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Book_rS> _ 

Copyright N° o opy'gj 


CGKOIIGHT DEPOSIT. 









































Legal Aspects 
Of Credit 


By 

STANLEY F. BREWSTER’ T. D. 

v» 5 J 

Member of Federal Bar 
Lecturer on Finance, New York University 




NEW YORK 

THE RONALD PRESS COMPANY 

1923 


.'£> loS 


Copyright, 1923, by 
The Ronald Press Company 


All Rights Reserved 



JAN i ? 73 



©Cl *092023 










PREFACE 


The primary object of the book is to train men engaged in 
credit work in the phases of the law with which they con¬ 
stantly come into contact, for it is of the utmost importance 
for credit men to have at least a general knowledge of their 
employers’ legal rights and remedies, as they otherwise cannot 
serve and protect the interests of their employers to the greatest 
advantage. In fact, on the score of practical utility, the value 
of legal knowledge for business men generally is not to be 
questioned. Most business men who have achieved marked 
success will admit that they owe it in some degree to a more or 
less thorough acquaintance with the law. In like manner the 
success of the credit man depends in a considerable measure 
upon his knowledge of the particular branch of the law re¬ 
lating to his chosen field of work. 

While a study of the information contained in this volume 
will not enable the credit man to dispense entirely with pro¬ 
fessional legal advice, it should give him a sufficient grounding 
in certain phases of the law to enable him frequently to get 
proper legal redress without incurring the expense of consult¬ 
ing an attorney. Consequently, particular pains have been 
taken to present the technical phases of the subject in as simple 
a manner as possible. 

As supplementing its main purpose, the book also aims to 
give a simple but fairly thorough exposition of the funda¬ 
mental principles involved in credit-granting. Thus, though 
designed primarily for credit executives, it may also be used to 
advantage by the younger men of credit departments. Finally, 
the book being partly the outgrowth* of a course of university 
lectures, should serve helpfully as a reference work for students 
of commerce in the various schools, colleges, and universities. 


in 


IV 


PREFACE 


Many sources of information were utilized in the compila¬ 
tion of this volume, inasmuch as it has necessarily involved a 
careful consideration of what has been written by other writers 
on the various aspects of the subject, and the author has en¬ 
deavored to give proper credit throughout the book wherever 
material of any consequence has been utilized. 


New York University 
December 15, 1922. 


S. F. B. 


CONTENTS 


Chapter Page 

Introduction—Function of Credit as a Substitute 
for Money. 3 

Part I—Types of Business Organizations and Their 

Legal Liability 

I The Sole Proprietorship . 7 

II Partnerships and the Unincorporated Association . 11 


III The Corporation.28 

Part II—Legal Nature of Sales 

IV Sales and Sales Contracts.45 

V The Passing of Title. 61 

VI Warranties.72 

Express Warranties 
Implied Warranties 
Remedies for Breach of Warranty 


VII Laws Governing the Validity of Sales Contracts . 78 

Part III—Safeguarding Payment in the Sale of Goods 

VIII Analysis of Mercantile Credit.85 

IX Sources of Credit Information .98 

X Preparation and Analysis of Financial State¬ 
ments . . . . # .114 

XI Description and Valuation of Assets and Lia¬ 
bilities .131 

XII Analysis of Corporate Financial Statements ... 144 
The Balance Sheet 

XIII Income or Profit and Loss Statement.159 

XIV Laws on Publication of Financial Statements . . 169 

%* 

XV Comparative Statement Analysis.179 

XVI Significance of Working Capital.194 

The Business Cycle 


v 
















VI 


CONTENTS 


Chapter Page 

Part IV—Incidental Factors Affecting a Concern’s 

Credit Standing 

XVII Manner of Payment.205 

XVIII The Securing of Accounts .212 


Legal Distinction between the Obligations of Guaranty 
and Surety 

Legal Distinction between Guaranty of Payment and 
Guaranty of Collection 


XIX Chattel Mortgages.220 

XX Credit Insurance.227 

XXI Granting of Extensions.236 

XXII Trade Abuses.243 


Part V—Legal Rights and Remedies of Mercantile 

Creditors 


XXIII Effecting the Collection.259 

XXIV Legal Process.270 


Bringing of the Case and the Parties into Court 

Framing of an Issue 

Hearing or Trial 

Judgment 

Appeal 

Execution 

The Return 

Supplementary Proceedings 

XXV General Rights and Remedies.299 

Of the Seller 
Unpaid Seller’s Lien 
Stoppage in Transit 
Right of Resale 
Right of Rescission 
Action for Breach of Contract 
Of the Buyer 

Action for Conversion 
Action for Breach of Contract 
Specific Performance 
Action for Breach of Warranty 


XXVI The Provisional Remedy of Attachment .316 

XXVII The Provisional Remedy of Garnishment.341 

XXVIII The Provisional Remedy of Replevin .352 

XXIX The Bulk Sales Law .358 

XXX Commercial Fraud.368 

Reluctance to Prosecute for Fraud 


Practical Difficulties Encountered in the Prosecution 
of Fraud 

Criminal Prosecution No Bar to Civil Action for Damages 


















CONTENTS vii 

Chapter Page 

XXXI Carrier’s Liability for Goods in Transit. 374 

The Interstate Commerce Commission 
Uniform Bills of Lading Acts 

Part VI—Credit as a Medium of Exchange 

XXXII Assignment of Book Accounts.397 

XXXIII Negotiable Instruments and Documents of Title . 403 

XXXIV Negotiation. 419 

XXXV The Trade Acceptance .433 

Part VII—Insolvency Proceedings 

XXXVI The Theory of Insolvency Legislation. 443 

XXXVII Adjustments . 446 

XXXVIII Assignments. 456 

XXXIX Receivership. 481 

XL Bankruptcy. 498 

XLI The Handling of Insolvent Estates. 529 











FORMS 


Forms Page 

A Sale.46 

A Contract to Sell.46 

Memorandum of Sale.56 

Conditional Sales Agreement.68 

Balance Sheet of a Sole Proprietorship or a Partnership.118 

Standard Form of Balance Sheet Adopted by the National Credit 
Men’s Association for Sole Proprietorship or Partnership . . 120, 121 
Standard Form of Corporation Balance Sheet Adopted by the 

National Credit Men’s Association.156, 157 

Balance Sheet of a Corporation.158 

Comparative Statement.183 

Informal Guaranty.212 

Formal Guaranty.213 

Continuing Guaranty.215 

Chattel Mortgage.221 

Statement of Claim.274 

Affidavit in Proof of Claim.275 

Summons Served on Debtor.276 

Affidavit for Attachment of Goods.330 

Notice of Garnishment.343 

Writ of Replevin. 353 

Promissory Note.407 

Commercial Draft.408 

Bank Check.408 

Post Office Money Order.413 

Notice of Dishonor.425 

Certificate of Protest.*..427 

Trade Acceptance.434 

General Assignment for Benefit of Creditors.462 

(a) Proof of Debt Filed in Bankruptcy Proceedings.513 

(b) Power of Attorney (Reverse of Proof of Debt).514 

29. General Letter of Attorney in Fact ..515 


1. 

2. 

3 - 

4 - 

5 - 
6 . 


8 . 

9 - 

10. 

11. 

12. 

13 . 

14. 
15 - 
16. 
17 - 

18. 

19. 

20. 

21. 

22. 
23 - 
24. 
25 - 

26. 

27. 

28. 
































Legal Aspects of Credit 






































































































































































































































































































































































■ 























































INTRODUCTION 


FUNCTION OF CREDIT AS A SUBSTITUTE FOR 

MONEY 

Before proceeding with the discussion of the principles on 
which the extension of credit is based, it is only fitting that 
we should first consider briefly the manner in which credit 
functions in the commercial world as a substitute for money. 
This is no mean task, as no less an authority than the eminent 
economist, John Stuart Mill, has stated that “the functions of 
credit have been a subject of as much misunderstanding and 
confusion of ideas as any single topic in Political Economy, 
due not to any particular difficulty in the theory of the sub¬ 
ject, but to the complex nature of the mercantile phenomena 
arising from the forms in which credit clothes itself.” 

“As an example,” continues Mr. Mill, “credit has a great, 
but not, as many people seem to suppose, a magical power; 
it cannot make something out of nothing. How often is an 
extension of credit talked of as an equivalent to a creation of 
capital, or, as if credit actually were capital. It seems strange 
that there should be any need to point out that, credit being 
only permission to use the capital of another person, the means 
of production cannot be increased by it, but only transferred; 
that is, if the borrower’s means of production are increased 
by the credit given him, that of the lender are correspondingly 
diminished, as the same capital cannot be used as such both by 
the owner and also the person to whom it is lent.” 

But though credit is never anything more than a transfer 
of capital from hand to hand, at interest, it is generally, and 
logically, a transfer to hands more competent to employ the 
capital efficiently in production; and capital thus circum- 

3 


4 


INTRODUCTION 


stanced forms a large portion of the productive resources of 
any commercial enterprise, or community. 

To illustrate, suppose A, B, and C have formed a company 
for the manufacture of shoes, into which each has put $10,000. 
The company sells D, a retailer, a bill of goods amounting to 
$200, terms 30 days net. Of the $30,000 capital, let us 
assume $8,000 was invested in manufacturing equipment, 
$8,000 in raw material, $2,000 in advertising, and $4,000 in 
cost of production; the remaining $8,000 constituting a reserve 
for current running expenses. In other words, $30,000 cash 
capital is now represented by the plant equipment, public knowl¬ 
edge of the enterprise, and the manufactured product (so many 
pairs of shoes). So when $200 worth of shoes is shipped to 
D the company is parting with a fractional share of what now 
represents its $30,000 capital; that is, it is practically loaning 
D a portion of its $30,000, or, to put it in still another way, 
it is transferring the use of approximately $200 of its capital 
to him for 30 days. Of course, the sale will actually represent 
somewhat less than $200 of the company’s capital; otherwise 
it would not be operating at a profit. D in turn will probably 
realize at least $250 on the sale of the shoes, or $50 on the 
use of the capital loaned to him, before making a repayment 
of the loan at the expiration of the 30 days. 

The foregoing thus sets forth in a general way the true 
relation, or function, of credit to the productive resources of 
a mercantile enterprise. We may, therefore, summarize our 
conclusions by defining credit as nothing more than a process 
whereby the use of capital is transferred from one party to 
another, measured in amount by the recipient’s power to borrow 
on the one hand, and the confidence reposed in his paying 
propensities on the other. It is also significant to note in this 
connection the fact that the word “credit,” implying faith or 
trust, is a direct derivation from the Latin word credo, mean¬ 
ing, “I believe.” 


PART I 


TYPES OF BUSINESS ORGANIZATIONS 
AND THEIR LEGAL LIABILITY 



CHAPTER I 

THE SOLE PROPRIETORSHIP 


Defining Credit 

The fact that there is such a great variance to be found 
in the numerous definitions of credit is not to be attributed 
to any lack of knowledge concerning the fundamental concept 
with which we are dealing, but rather to the fact that the 
general term “credit” is sufficiently broad in scope to permit 
of its being construed differently when the subject is consid¬ 
ered from different standpoints. In most instances, however, 
it will be found that whatever difference exists is more a matter 
of form and use of words than of substance; in that the defi¬ 
nitions all agree to this extent—the extension of mercantile 
credit necessarily involves the acceptance of a buyer’s promise 
to pay in the future in return for a present sale and delivery 
of goods by the seller. 

Whether a seller is justified in parting with his goods 
in return for such a promise to pay for them at some future 
time will depend largely upon two factors: 

1. The amount of faith he has in the buyer’s ability to 

carry out his promise—his confidence in the buyer’s 
future ability to pay. 

2 . The extent to which he can actually hold the buyer 

legally responsible for his promise in the event he 
fails to fulfil it. 

Basic Types of Business Organization 

As a condition precedent to the determination of the extent 
to which a seller of merchandise can actually hold a buyer 
legally responsible for his promise, or, in other words, to the 

7 


8 


TYPES OF BUSINESS ORGANIZATIONS 


determination of one’s legal rights and remedies arising out 
of the sale and contracts to sell goods, it is necessary to know 
the type of business organization with which you are dealing. 
This is because there are, as we shall see, various forms of 
organization by means of which business may be transacted, 
and what is of particular significance to a credit man is the 
fact that the legal liability of the interested parties may vary 
in both its nature and extent in accordance with the form of 
the organization in which they are interested. For this reason 
a preliminary discussion of the more important features of 
these forms of business organization and their respective legal 
liability is not out of place. 

Throughout the world, wherever business enterprises are 
carried on, there are to be found three basic forms in which 
the ownership of the enterprises is held: 

1. The individual owning outright his own business and 

usually managing it himself. This constitutes what 
is termed “the sole proprietorship.” The simplicity 
of this form does not necessarily imply, however, 
that it is applicable only to a small business. 

2. A group of two or more owners working together 

and conducting the business as co-owners for their 
joint profit under some form of partnership agree¬ 
ment. 

3. The impersonal owner—the corporation—serving as an 

intangible intermediate legal entity between the busi¬ 
ness and the individuals who have various kinds and 
degrees of claims upon the business. 

Other Types 

In addition to these three basic forms, there are three other 
forms of business organization which are sometimes, though 
not so frequently, used in the conduct of business enterprises. 
These are the limited partnership, the joint-stock company, 
and the unincorporated association. 


THE SOLE PROPRIETORSHIP 


9 


Definition of Sole Proprietorship 

The first of the three basic forms of business organization 
—the sole proprietorship—is the simplest and most numerous. 
A sole proprietor is one who conducts his business in person 
or through agents without admitting anyone else to share the 
profits. He alone owns the property in the business, and he 
alone decides the policy to be pursued in its management. He 
may, of course, have agents to whom he entrusts important 
matters, but they are his employees and are responsible to him 
alone. 

There are no special laws affecting the rights of an indi¬ 
vidual to engage as a sole proprietor in whatever business 
he may desire, so long as such business is conducted within 
the scope of the general law or statutes. He may conduct such 
business as he sees fit, so long as he is mindful of his legal 
relations to the government and the individuals or companies 
with which he does business. In other words, the sole pro¬ 
prietor of a business has the broadest opportunity to do as 
he pleases. He may even conduct the business under an 
assumed name, either that of an individual, firm, or company, 
if he complies with the law. 

Statutory Restrictions 

Statutes, however, generally require that he shall file in the 
office of the clerk of the county court in which the business is 
conducted, a certificate setting forth the name under which the 
business is conducted together with the name and correct post 
office address of the party or parties conducting it. 

The purpose of the state legislatures in enacting such 
statutes is nowhere better expressed than in the case of Sagal 
v. Fylar .- 1 

The remedial purpose of the statute manifestly was that 

the public should have ready means of information as to the 


1 89 Conn. 293. 



IO 


TYPES OF BUSINESS ORGANIZATIONS 


personal or financial responsibility behind the assumed name. 

It was for the protection of those who might deal with or give 
credit to the fictitious entity. It absolutely was not to provide 
means by which persons having received a benefit from another 
should be enabled to retain it without compensation and to 
repudiate any agreement for compensation. 

The statutes are usually penal in their nature and provide 
a fine or imprisonment for violation. But in some states, 
notably California, Colorado, Kentucky, Massachusetts, Okla¬ 
homa, Oregon, and Pennsylvania, no action upon contract can 
be maintained by an individual or partnership which has failed 
to comply with the statutes. In Arizona, Indiana, Michigan, 
Minnesota, Montana, South Dakota, Vermont, and Washing¬ 
ton, failure to file the required certificate can be cured, pro¬ 
vided the certificate is filed prior to the institution of suit, even 
though the certificate was not on file at the time the cause 
of action arose. 2 

Legal Liability 

The law does not recognize any distinction between the 
sole proprietor of a business as a legal entity, and the same 
party as a private individual or social being. The debts of the 
business are the proprietor’s debts, regardless of his other 
outside interests. In other words, he cannot legally separate 
his personal property from that devoted to his business. When 
creditors sue, they sue the individual, and if the assets of the 
business are not sufficient to satisfy the judgment, such judg¬ 
ment creditors may have recourse to any other assets which 
he may own outside of the business. 

2 For a complete digest of the various state statutes, see Credit Men’s Manual of Commer¬ 
cial Laws. 



CHAPTER II 


PARTNERSHIPS AND THE UNINCORPORATED 

ASSOCIATION 


Definition 

A partnership is a legal relation existing between two or 
more competent persons who have agreed to combine their 
labor, property, or skill for the purpose of engaging in any 
lawful business for their joint profit. Fundamentally, there 
is no essential difference between the sole proprietorship and 
the ordinary partnership, except that in the latter case there 
is a group of owners instead of one individual owner. 

There are several different forms of partnership relation 
which may be entered into. They are usually classified as: 

1. General or ordinary partnerships 

2. Limited partnerships and 

3. Joint stock companies 

depending upon the nature of the partnership agreement en¬ 
tered into between the parties. But all three classes represent 
types of organizations which are based on a contractual rela¬ 
tion, either express or implied, entered into between parties 
competent to contract. 

1. General Partnerships 

This is the most common type of partnership organization. 
Such a partnership may be created for carrying on any lawful 
business, and as a general rule whatever the members could 
do acting individually may lawfully be done in partnership. 

No particular formalities are required in the formation of 
the general partnership, and an express agreement is not essen- 


11 


12 


TYPES OF BUSINESS ORGANIZATIONS 


tial. All that it is necessary to prove is that the partners have 
agreed to do business and to share the profits as proprietors. 
If that is proved they are partners, whether they meant to be 
or not. Any statement or reservation in such an agreement 
to the effect that they shall not be partners merely affects their 
relation to each other, but as to outsiders or creditors they are 
partners. 

The United States Supreme Court has laid down this test 
to determine whether or not a partnership relation exists: 

1. Was there a business in common? 

2 . Did the parties receive a share of the profits from that 

business as principals? 

Articles of Copartnership 

Where the terms of the agreement are expressed, they are 
generally embodied in what are termed “articles of copartner¬ 
ship.” Inasmuch as the partners, or contracting parties, may 
agree upon any terms or arrangement they may choose, no 
matter how unusual, so long as it does not violate the law, such 
articles of copartners should always be closely scrutinized, 
when possible, for the purpose of ascertaining the true nature 
of the undertaking and the extent to which each of the con¬ 
tracting parties is interested os between themselves. For exam¬ 
ple, suppose the agreement provided that all the partners were 
to share profits equally, but certain phases of the management 
were to be vested in a particular partner or partners. The 
credit man would be interested in knowing this in calculating 
the firm’s prospects of success. Many credit men have found 
out to their sorrow that partnerships are many-sided and not 
all they might be. 

Who May be Partners 

Any person capable of entering into contract may be a 
partner. An infant (meaning a person under legal age) may 
be a partner, but his contract of partnership is voidable and 


PARTNERSHIPS 


13 


he may interpose his infancy as a defense against personal 
liability. While such a partnership relation exists, he has all 
the rights of a partner. And even though he later disaffirms 
his contract of partnership, his interest in the firm property 
remains liable for partnership debts. In fact, this is the extent 
of an infant partner’s liability after his partnership agreement 
has been disaffirmed. 

A corporate enterprise cannot be a partner. Two or more 
firms may form a partnership. Likewise a firm and an indi¬ 
vidual. A partner may also form a subpartnership with a 
third party as to his particular interest. 

Nature of Partnership 

What constitutes a partnership is a question of law. 

/ 

Whether the facts in a given case constitute a partnership is 
a question of fact to be proved by evidence of the articles of 
copartnership, books, business conduct, or individual testimony. 

Where a partnership relation is created by an expressed or 
implied agreement, and is dependent upon the intention of the 
parties, and where the element of sharing profits and losses is 
present, it may be said to be strong but not necessarily con¬ 
clusive evidence that the parties have united as principals for 
their joint profit. In other words, where a concern employs 
an agent to get contracts and agrees to pay him a share of the 
profits instead of a salary, and, in order to make him cautious 
in choosing the parties with whom to contract, further agrees 
that he is to share the losses—he is not a partner because it 
was never intended that he should thereby become a coprincipal 
in the business. Likewise, one who receives a share of the 
profits in repayment for an advancement made to the firm 
capital is not a partner. 

Suppose the agreement provides for the sharing of profits 
but not losses. If one party furnishes all the capital and the 
other shares in the profits as compensation for his services, 
such an agreement would not constitute a partnership; but if 


H 


TYPES OF BUSINESS ORGANIZATIONS 


both contribute and are to share the profits as principals and 
agents for one another, they are legal partners. In other words, 
the parties must own the business in common to be legal 
partners. 

The Firm Name 

In the absence of statutory provisions any name may be 
used under which to conduct the business, but unless author¬ 
ized by statute, legal action cannot be maintained either by or 
against the partnership in the firm name—the action must be 
brought in the individual names of the partners. And if there 
are three partners and only two of them are sued, the action 
is subject to a plea in abatement on the ground that one of 
the partners was not joined in the action. Otherwise the judg¬ 
ment will be taken against the two only and will not bind the 
individual interest of the other partner. 

Firm property, personal or real, may be held in the name 
of one partner, but a partnership cannot take or hold real 
property in the firm name. The conveyance must be made to 
the individual members of the firm. 

Suppose, however, that land is found to be held in the name 
of one partner? If purchased with partnership funds, used 
for partnership purposes, and carried on the books as firm 
property, it is firm property and the partner holds it subject to 
a resultant trust in favor of the firm. 

One partner cannot sue the firm at law because he would 
necessarily be both plaintiff and defendant to the action. Nor, 
for similar reasons, can the firm sue one of the partners. A 
court of equity is the proper tribunal for the settling of part¬ 
nership controversies, generally upon a request for an ac¬ 
counting. 

Manner of Accounting 

In distributing the proceeds upon dissolution, the losses 
are to be paid first out of the assets, excluding capital. Next, 


PARTNERSHIPS 


15 


out of the capital, and finally, by recourse to the partners 
individually. 

The assets of the firm should be applied as follows: 

1. In paying liabilities of the firm to non-partners. 

2. In paying each partner what is due him from the firm 

for advances, as distinguished from capital. 

3. In paying each partner ratably the amount due him in 

respect of capital. 

4. The residue to be divisible as profit. 

As a general rule, and in the absence of an express 
agreement to the contrary, partners bear losses in the same 
proportion in which they share profits, even though one has 
contributed the entire capital. 

Dissolution 

The dissolution of a partnership is defined in the Uniform 
Partnership Act as the “change in the relation of the partners 
caused by any partner ceasing to be associated in the carrying 
on, as distinguished from the winding-up, of a business.” The 
effect of the dissolution is to terminate the agency relation 
existing between the partners. 

To say a partnership has been dissolved is to say that the 
relation which subsisted between persons who were carry¬ 
ing on a business in common with a view to profit, has been 
terminated. As soon as this relation has been discontinued, 
the powers of the associates which are conferred by the part¬ 
nership relation, are withdrawn. Consequently, if new busi¬ 
ness engagements are entered into, they are binding upon the 
individuals who have made or have actually authorized them, 
but upon no others. 

If, upon dissolution, the partners are unable to agree upon 
the manner and process whereby the business is to be liqui¬ 
dated, it is competent for any partner to apply, in case of 
necessity, for a receiver and have the affairs of the partnership 
wound up under the direction of the court 


16 TYPES OF BUSINESS ORGANIZATIONS 

Termination of the Partnership 

The termination of a partnership does not mean that the 
business is to be immediately discontinued but that the respec¬ 
tive rights of the partners are to be determined as of the time 
of termination. It may be brought about by: 

1. Lapse of the time specified. 

2. Accomplishment of the object for which it was 

organized. 

3. Consent of all parties. 

4. Withdrawal of a partner. 

If the partnership was created for no definite length of 
time—a partnership “at will”—it may be terminated by any 
partner at any time without incurring any liability. When 
created for a definite period, each partner has the power to 
withdraw and terminate the right of the other partners to bind 
him further, but in so doing he subjects himself to an action 
for damages. 

5. Death of a partner. 

Upon the death of one partner, title to all firm property 
and assets vests in the other partners and it is their duty to 
close up the business and render an accounting to representa¬ 
tives of the deceased’s estate in order that the value of the 
interest of the deceased partner may be determined. As to 
realty, the legal title vests in the surviving partner and the 
heir of the deceased partner jointly, but the surviving partner 
can compel the heir to join in a deed of conveyance if the 
surviving partner sells the property in winding up the business. 
And this he may do without the consent of the deceased part¬ 
ner’s legal representative. The business may be continued with 
the consent of the deceased’s beneficiaries, but upon dissolution 
no new obligations may be incurred by the firm unless inci¬ 
dental to the closing up of the business. In case of the death 
of a partner, a firm creditor is obliged to exhaust his remedy 


PARTNERSHIPS 


17 

against the surviving partners before he can collect from the 
decedent’s estate. 

6. Bankruptcy of a partner or the firm. 

7. War between nations represented by partners. 

8. Insanity or serious misconduct on the part of one 

partner which permits the other partner or partners 
to apply to the court for a dissolution. 

In the absence of statute, no partner has the right to insist 
that firm creditors shall exhaust the firm assets before having 
recourse to the partners as individuals. In other words, 
although it is necessary to sue them all jointly, once a judg¬ 
ment has been obtained, you can collect from any one partner 
separately and individually. In such cases, where execution is 
satisfied against the personal assets of one of the partners, the 
partner obtains a lien on the firm assets and partnership prop¬ 
erty. This is the general rule, but there are exceptions to it. 
In New York, for instance, firm assets must be exhausted 
before the private property of the partners can be taken under 
a judgment. 

Legal Liability 

Each general partner is an agent for the partnership in the 
transaction of its business and has authority to do whatever 
is necessary to carry on the business. He acts as principal 
for himself and as agent for the other partners. Consequently, 
each general partner is personally liable to third parties for all 
the partnership obligations. For instance, a note payable to 
the firm may be indorsed in the firm name by one of the 
partners. In such case the firm signature is equivalent to the 
individual signature of all the partners. For the same reason 
a partner can mortgage or transfer the entire firm property 
to pay firm debts, and such transfer cannot be attacked by 
creditors if the firm was solvent at the time of the transfer. 
In some states, as Ohio, a partner has implied power to make 


18 TYPES OF BUSINESS ORGANIZATIONS 

a general assignment; whereas in others, as New York, he has 
no such implied power unless the other partners are absent or 
inaccessible. 

In one sense the legal liability of copartners is not only 
joint but several, because if a judgment is obtained against all, 
execution may be issued against the individual interest of any 
one of them. (In New York, where only one partner is served 
with process, the judgment is binding on all, but it binds only 
the firm assets and the individual assets or property of the 
partner served.) 

The old view was that partners were tenants in common 
and each held an undivided portion of the firm assets or prop¬ 
erty. The modern view, however, is that a partner’s interest 
is simply a right of action to the surplus remaining after the 
firm debts are paid. Consequently, an individual creditor of 
one of the partners can acquire no greater right in the firm 
property. A partner can execute a valid mortgage on partner¬ 
ship property to secure his individual debts, but such a mort¬ 
gagee obtains only a lien on whatever surplus remains after 
the affairs of the firm are settled and his equity in the business 
is thereby ascertained. And it has been held that if a sheriff 
attempts to levy on partnership property to satisfy a judgment 
against a partner’s individual property, he is guilty of conver¬ 
sion. The sheriff may take possession of the property and 
can be dispossessed only by the partners giving bond—such 
possession of the sheriff to continue in effect until an account¬ 
ing has been made—but all that he may sell is the particular 
partner’s interest in the firm property as determined by an 
accounting. 

Rights and Remedies of Partnership Creditors 

Firm creditors have a right to have the partnership property 
applied first to the payment of the partnership debts. An indi¬ 
vidual creditor of a partner cannot attach the partner’s interest 
in the partnership property to the prejudice of the partnership 


PARTNERSHIPS 


19 


creditors. After the firm creditors are paid, the separate cred¬ 
itors of a partner are entitled to any surplus belonging to 
him. 

The weight of authority is also in favor of the converse 
of this rule, namely, that the separate creditors of a partner 
are entitled to be paid first out of his separate estate. After 
the separate creditors are paid, the partnership creditors are 
entitled to the surplus. An exception to this general rule is: 
“Where there is no living solvent partner and no firm assets, 
the firm creditors share equally in the individual assets with 
the individual creditors.” 

In other words, the principle underlying the legal liability 
of partners may be briefly stated as follows: The joint estate is 
applied to the payment of joint debts, and the separate estate 
to the payment of separate debts, any surplus from either estate 
being applied in settlement of the other, and vice versa, if 
necessary. But this applies only when there are partnership 
assets. If there are no partnership assets, and no living solvent 
partner, the firm creditors share equally with the individual 
creditors. 

Exemption statutes apply to individuals only, and a partner 
is not allowed any exemption as a partner. 

A partner, while he has implied power to buy and sell part¬ 
nership property, has not an implied power to use the firm 
property to pay his own debts, and the firm may recover such 
property even from an innocent purchaser for value without 
notice. It is not a question of knowledge on the part of the 
one who receives it, but of the authority of the partner to 
make such transfer. But if the innocent purchaser for value 
reconveys it to a third party, the third party can keep the 
property, the theory of the distinction being that a creditor is 
not a purchaser for value without notice. In other words, the 
law makes a distinction between one who received the property 
in payment of an antecedent debt and one who receives it for 
value. 


20 


TYPES OF BUSINESS ORGANIZATIONS 


Rights of Creditors When Not Notified of Change in Per¬ 
sonnel 

The formation of a partnership results in creating not only 
a relationship between the partners, to which the law attaches 
certain rights and liabilities, but also between the partnership 
so created and third persons, or creditors, who deal with it as 
a business entity. If there is any change made in the personnel 
of the partnership, it would seem only right and proper that 
the creditors of the firm should be promptly notified accord¬ 
ingly. In fact, such notice is required to two classes of 
creditors: (i) to those who have extended credit to the firm, 
and (2) to those who have not extended credit to the firm prior 
to the change in personnel but do so subsequent thereto. 

1. Creditors Who Have Extended Credit to the 
Firm Prior to the Change. In this case the rule has been 
laid down: 

To relieve a retiring partner from liability for subsequent 
transactions in the firm name, notice of the dissolution must be 
brought home to the persons giving credit to the partnership. 

If, in any way, by actual notice served, or by seeing the publi¬ 
cation of the dissolution, or by information derived from third 
persons, the party at the time of the dealing is made aware of 
the fact that the partnership has been dissolved, the contract 
will not bind the firm. 

In other words, a retired partner is liable to a creditor for 
firm debts if he has permitted the other partners to use his 
name and “no notice was given.” 

Professor Mechem says: 

A common way of giving the notice is by personal commu¬ 
nication, or by letter or circular addressed to all persons who 
have in the past extended credit to the firm. Mailing the 
notice, properly addressed, raises a presumption of its due re¬ 
ceipt, but the presumption is not conclusive, and if rebutted, 
actual receipt must be shown. Mere publication in a news¬ 
paper is obviously not enough; it must appear further that the 
party to be notified actually saw it or otherwise knew of it. 



PARTNERSHIPS 


21 


2. Creditors Who Extend Credit to the Firm Subse¬ 
quent to the Change. As for the second class of creditors, 
Professor Mechem states: 

In the case of creditors who did not know of the partnership 
personnel prior to its dissolution, no notice at all is necessary, 
upon the ground that as they did not learn of the existence of 
the partnership until after it had actually been dissolved, they 
could not have been misled by prior appearances, and there¬ 
fore they could have no reason for holding it liable. But where 
the creditor knew of the partnership but had not dealt with it 
prior to its dissolution, a “general” notice is enough, and this 
notice may be given in a variety of ways, though publication 
for a reasonable period in a newspaper of general circulation 
at the place where the partnership business is carried on, is 
deemed the most effectual and appropriate. 

Where a partnership is dissolved or a known member of 
the firm retires under circumstances requiring notice, then, 
until notice of the dissolution or retirement has been properly 
given, the power of each partner to continue to bind the others 
by contracts within the scope of the business made with credi¬ 
tors entitled to notice, remains unimpaired, although as between 
the partners themselves his authority may have terminated. 

2. Limited Partnerships 

Two or more persons may form what is known as a “lim¬ 
ited partnership” for the purpose of engaging in any lawful 
business except banking and insurance. Partnerships of this 
nature, however, can be organized only when permitted by 
statute. Such a statute has been enacted for this purpose in a 
majority of the states. 

The purpose of creating a limited partnership is to permit 
the formation of partnerships in which some of the partners 
who conduct the business shall have general personal liability, 
while others, the “special partners,” who take no part in the 
management, may contribute a given amount and assume no 
further liability. 


22 


TYPES OF BUSINESS ORGANIZATIONS 


In other words, the business of such limited partnerships 
is carried on by the general partners, who alone represent the 
firm. In fact, if a special partner participates in the manage¬ 
ment he becomes liable as a general partner. Contracts must 
therefore be made by and in the name of the general partners, 
and suits must be brought by and against them alone. 

This type or form of business organization still continues 
in favor throughout the British Empire, but the movement has 
not gone very far in the United States because of the superior 
advantages of the corporate form. 

Organization of Limited Partnership 

In most states special statutes require, for the formation 
of a limited partnership, the execution of a certificate, to be 
filed and recorded in the clerk’s office of the county in which 
the principal place of business is located. It sets forth: 

1. Name of firm under which the business is to be con¬ 

ducted. 

2. General nature of the business to be transacted. 

3. Names, and whether of full age, of all general and 

special partners. 

4. Amount of capital contributed by each special partner. 

5. Time at which the partnership is to begin and end. 

The names of the general partners must, as a general rule, 
appear in the firm name, and some of the state statutes also 
require that the word “Limited” be added. Others require the 
display of a sign in a conspicuous place outside the place of 
business showing the names in full of all partners and indi¬ 
cating which are general and which are special partners. 

Legal Liability of Limited Partnership 

It has been held that unless there has been at least a 
substantially full and exact compliance with the statutory 
provisions, the special partners will be liable as general part¬ 
ners to third persons, or creditors. In other words, a limited 


PARTNERSHIPS 


23 


partnership that has not so complied with the statutory require¬ 
ments is not a limited partnership in fact, but a partnership 
in which all the partners are liable as general partners. 

The members of a limited partnership, either before or 
after insolvency, are liable for the partnership debts in the same 
manner and to the same extent as general partners; and their 
creditors are entitled to recover judgments against them with 
a view to satisfying their judgment out of either or both the 
individual or partnership assets, subject, of course, to the 
restricted liability of the special partners. 

Interest in Partnership Non-Transferable 

In the general or ordinary partnership, all of the members 
of the firm are co-owners of the whole of the partnership 
property. Such being the nature ascribed to a partner’s share, 
it is clear that he has no individual title to any specific part or 
portion of the partnership property, and consequently can 
neither sell nor assign any part or portion of it as his own. 

A partner may, however, transfer such interest in the part¬ 
nership as he has, but the transfer of his interest does not 
operate to work a substitution of the grantee as a new member 
of the firm, but has the effect of dissolving the partnership, 
leaving to the grantee the right to the value of the share thus 
acquired as determined by the final accounting. The reason 
for this is that the fiduciary relation that exists between 
partners demands mutual trust and confidence, and the right 
to choose one’s own partners is properly regarded as one of the 
most important characteristics of a partnership. 

3. Joint-Stock Companies Defined 

An exception to this rule of dissolution exists in the case 
of a joint-stock company, which may be defined as “an ordinary 
partnership except that, by the original contract of the mem¬ 
bers, it is agreed that any member may transfer his share and 
that his transferee shall accordingly be received into the part- 


24 


TYPES OF BUSINESS ORGANIZATIONS 


nership.” In other words, it is merely a partnership with trans¬ 
ferable shares, wherein the holders may transfer their shares 
or interest exactly as stockholders do in a corporation. 

These companies constitute an abnormal kind of partner¬ 
ship, possessing some of the characteristics of a corporation, 
and are a form of business organization that was at one time 
popular (particularly throughout the British Empire) but 
which in this country is now practically obsolete. (The Adams 
Express Company is a joint-stock company.) While joint- 
stock companies possess certain of the characteristics of a 
corporation, they are not such because: 

1. The debt of a corporation is its own debt, whereas the 

debt of a joint-stock company is that of its members. 

2. A joint-stock company derives authority for its ex¬ 

istence from a contract of individuals, whereas a 

corporation derives authority for its existence from 

the sovereignty of the state. 

The personality of the members, so important in the case 
of the general partnership, ceases to be important in such an 
organization, for usually they are large partnerships and by 
mutual consent the management of the business is generally 
vested in and confined to a few persons who may or may not 
be shareholders. 

The main points of difference between a joint-stock com¬ 
pany and a partnership may be said to be: 

1. The transfer of shares or the death of one member 

does not dissolve the campany. 

2. Management of the business is vested in a board of 

directors or selected officers. 

3. The right of one member of the company to bind the 

company does not exist as in a partnership. 

Legal Liability of Joint-Stock Companies 

Joint-stock companies are similar to ordinary partnerships 
with respect to legal liability in that each member, or share- 


PARTNERSHIPS 


25 


holder, is personally liable for the debts and obligations of the 
company so long as he remains a shareholder. In other words, 
the shareholder’s liability for company obligations is that of a 
general partner, and it cannot be limited by the articles of 
association. But a creditor must first exhaust his rights and 
remedies against the company and then collect the deficiency 
from the members. There is a distinction, however, to be made 
between the liability of an outgoing and an incoming share¬ 
holder. 

The liability of an outgoing partner to creditors for exist¬ 
ing debts is not usually affected by the agreement provision for 
the transfer of shares, and a shareholder cannot escape liability 
for existing obligations of the company by merely transferring 
his share. This is not true, however, as to obligations incurred 
subsequent to his withdrawal, provided proper notice has been 
given. 

The liability of an incoming shareholder to existing cred¬ 
itors is usually the same as that of a general partner, and he 
takes such share subject to all rights and liabilities attaching 
thereto. It therefore follows that a creditor would be afforded 
the option of suing either the company personnel as it existed 
at the time the indebtedness was incurred or as it existed at 
the time the suit was brought. 

However, in the ten states 1 in which the Uniform Partner¬ 
ship Act has been enacted, the liability of an incoming partner 
is modified to the extent that he incurs no personal liability for 
past debts, but that his interest in the partnership property is 
subject to such debts. 

Statutory Enactments 

Such companies may exist without statutory authority, 
although in a number of states statutes have been enacted 
providing for their creation and regulation. In such cases the 

1 Alaska, Illinois, Maryland, Michigan, New York, Pennsylvania, Tennessee, Virginia, 
Wisconsin, and Wyoming. 



26 


TYPES OF BUSINESS ORGANIZATIONS 


right to sue and be sued in the firm name is generally conferred 
as a matter of convenience, as the number of partners is likely 
to be greater than in ordinary partnerships. But in the absence 
of such statutory enactment all the members must join in any 
action by the company, and as many as the creditor wishes to 
hold must be joined in an action against the company. 

Unincorporated Associations and Societies 

Such organizations are not statutory entities, but are 
formed by mutual agreement and derive their power and unity 
of organization usually from an adopted constitution supple¬ 
mented by enacted by-laws. The object and purpose of such 
organizations is usually that of rendering some special service 
to the members or to the public, and not for pecuniary profit. 
If such an organization were actually engaged in carrying on 
a business for profit it would ordinarily be deemed a partner¬ 
ship. 

The most common types that the credit man has to deal 
with are the unincorporated social clubs, hospital associations, 
friendly societies, fraternities, and church and co-operative 
associations. 

Legal Liability of Unincorporated Associations and 

Societies 

Such bodies are not engaged in business, are not organized 
for pecuniary profit, and are therefore not partnerships within 
the legal significance of that term. Consequently the legal 
liability of a member of such an organization is not to be deter¬ 
mined by the law of partnership, but by the law governing the 
relation of principal and agent. 

Authority to bind the organization is usually vested in cer¬ 
tain selected officers or a board of trustees or some agent 
appointed by them for a particular purpose, e. g., the steward 
of a club, and no single member has authority to bind the 
association merely by virtue of his membership. 


PARTNERSHIPS 


27 


The liability of the members for debts and obligations 
incurred by the organization is the same as that of partners, 
provided the indebtedness was incurred within the scope of the 
organization’s purpose and by an authorized representative or 
agent—those members and those only being liable as principals 
who have expressly or impliedly authorized the acts to be done 
in their behalf, or who have subsequently ratified them. And 
if the obligation is not incurred in such manner, only the con¬ 
tracting members may be held, unless their action was later 
formally ratified by the organization. 

Just as care should always be exercised when dealing with 
minors, similar care should be exercised when dealing with 
clubs and associations. Be sure you know where the responsi¬ 
bility really rests, and whether the party you are dealing with 
has authority to obligate the other members. 


CHAPTER III 

THE CORPORATION 


Definition 

When so large a proportion of the business of the world is 
carried on under the corporate form of organization, it is abso¬ 
lutely essential that the credit man have at least a general 
knowledge of the organization of the corporation, its methods 
of acting and carrying on its business, and more particularly 
of the responsibilities and liabilities of the corporation itself, 
its officers, directors, and stockholders. 

A corporation is an artificial person created by statute law 
and endowed with many of the legal capacities of individuals, 
such as the power to take, hold, and convey property, make 
contracts, sue and be sued, and the like. Chief Justice Marshall 
defined a corporation as “an artificial being, invisible, intangi¬ 
ble, and existing only in contemplation of law.” Being a mere 
creature of the law, it possesses only those rights which are 
conferred upon it by the law as set forth in its charter. 

Test of Corporate Relation 

Private business corporations—those with which we are 
solely concerned—are intended to enable a number of interested 
parties to unite their capital in an enterprise with two important 
results: (i) the power to transfer their shares to other holders 
without affecting the business; and (2) the power to limit their 
personal liability for the debts, contracts, or torts, of the cor¬ 
poration. A general partnership accomplishes neither of these 
results. A special partnership accomplishes the second, but not 
the first. A joint-stock company accomplishes the first, but not 
the second. 


28 


THE CORPORATION 


29 


Regardless of the form or manner in which a business may 
be conducted, the true test as to whether it constitutes a cor¬ 
porate or partnership relation among the interested parties lies 
in the source from which the liability of the parties arises. If 
the liability is the result of their entering into a contract, it is a 
partnership—general, special, or joint-stock company; whereas 
if the sole source of the liability is a state law or statute, it is 
a corporation. In other words, the only thing necessary to 
create a corporation is the intent of the state legislature to that 
end. And the three so-called “requisites” of a corporation— 
perpetuity, limited liability, and transferability of shares—are 
not requisites, but merely characteristic features of a corpora¬ 
tion, inasmuch as they may be possessed by special forms of 
partnerships. 

Organization—The Charter 

The charter is the very basis of corporate existence—its 
“birth certificate”—which serves to bring the corporation into 
being as a business organization. Formerly charters consisted 
of special laws enacted by the legislatures creating specific cor¬ 
porations. It is now the policy of the law, however, to enact 
general corporation laws with which the incorporators must 
comply, and when they do they are entitled to their charter as 
a matter of course and right. When the incorporation is 
effected through the medium of such a general enabling act, 
a certificate of organization or association is granted, which, 
together with the provisions contained in the enabling act, 
constitute its charter. 

The procedure to obtain a charter under such laws consists 
in filing a certificate setting forth the facts required by law, 
which vary in different states and include the following: 

1. Name of the proposed corporation. 

2. Amount of its capital stock. 

3. Number of shares into which it is to be divided. 

4. Par value of such shares (if any). 


30 


TYPES OF BUSINESS ORGANIZATIONS 


5. Objects of the corporation. 

6. Location of its principal office. 

7. Names of the incorporators. 

This certificate is filed in the office of the Secretary of State 
and as a rule a copy of it must also be filed in the recorder’s 
office in the county in which the principal office of the corpora¬ 
tion is located. 

Who May Incorporate 

As a rule, any natural person who can enter into a binding 
contract relationship can properly act as an incorporator. This 
excludes minors, persons of unsound mind or otherwise incom¬ 
petent, firms, corporations, or anyone acting in a representative 
capacity. It does not exclude married women, who frequently 
act as incorporators. 

The minimum number of incorporators and the percentage 
of state residents required are prescribed by statute and vary 
in the different states. The Ohio statute requires five incor¬ 
porators, three of whom must be state residents, whereas in 
New Jersey none of the incorporators need be either a resident 
of the state or a citizen of the United States. 

The function of the incorporators is to serve as the active 
agents in bringing the corporation into existence. They apply 
for the charter, subscribe for stock, call and conduct the first 
meeting, and attend to all other legal requirements incidental 
to incorporating the business up to the point when it is actually 
ready and prepared to function and transact business as a 
corporate entity. 

Oftentimes, as a matter of convenience, or because they do 
not wish to disclose their identity, the real parties in interest 
will have what are called “dummy incorporators,” or persons 
without any material or permanent interest in the enterprise, 
to carry out the technical duties of incorporators. In such 
cases the dummy directors execute the charter and organize the 
corporation, usually subscribing for the smallest number of 


THE CORPORATION 


31 


shares required by statute. They later assign their stock and 
resign any official position they may hold in the corporation 
in favor of the real parties in interest. When properly con¬ 
ducted, such means of incorporating is entirely legal, and is 
the method pursued in the formation of almost all of the larger 
corporations. The United States Steel Corporation was incor¬ 
porated by three dummy incorporators, each of whom sub¬ 
scribed for 10 shares of stock out of a total capitalization of 
$3,000. As soon as the organization as a corporation was 
completed, the incorporators were retired and the capitalization 
was increased to $1,100,000,000. 

Corporate Purposes 

Whereas a sole proprietor or general partnership may en¬ 
gage in any form of business not prohibited by law, a corpora¬ 
tion may do only those things and engage in such business 
undertakings as are set forth in its charter. In other words, 
a corporation is a creature of limited powers. Things other¬ 
wise legal but not within the scope of its charter are entirely 
beyond its powers, or ultra vires. Such ultra vires contracts 
cannot be enforced against others, but usually bind the corpora¬ 
tion. Directors and officers may make themselves personally 
liable either to the corporation, its stockholders, or to third 
parties for involving the corporation in such unauthorized 
transactions. 

System of Stock Capitalization 

The capital stock of a corporation is divided into units 
called “shares,” which are issued to subscribers of the stock 
according to their respective interests. These shares have a 
par or face value determined by the proportion which the unit 
bears to the entire capital stock. Thus if the entire capitaliza¬ 
tion amounts to $100,000 and only 1,000 shares of stock are 
to be issued, the par value of each share is $100. However, 
the capital stock may be divided into as many shares as is con- 


32 


TYPES OF BUSINESS ORGANIZATIONS 


sidered desirable when obtaining the charter, but in practice 
it is customary to have shares of the par value of $5, $10, 
$50, or $100. In all states the maximum amount of capital 
stock that may be issued is fixed by and set forth in the charter. 
The amount may later be increased or diminished by charter 
amendment. 

Common and Preferred Stock 

Often the classification of shares into “common” and 
“preferred” is set forth. Preferred stock is that to which 
some preference has been given over other stock of the same 
corporation, as to participation in profits or dividends, and 
often in the corporate assets in case of liquidation. If there 
is no such distinction to be made in regard to these two fea¬ 
tures, the stock of a corporation is all common stock or simply 
“capital stock.” 

In a number of states, laws have been passed providing for 
the incorporation of stock companies with shares of unspeci¬ 
fied or no-par value, each of such shares merely representing 
a fractional interest in the profits and assets of the corporate 
enterprise. There is always a natural human tendency to asso¬ 
ciate the par value with the true value of the stock, and it was 
to escape this irresistible tendency that the unvalued share was 
devised, by forcing the public to investigate the real value of 
the shares. 

Fundamentally, there is no real difference between par and 
no-par shares—the real value of the share is the same whether 
its par value is $10 or $100, or nothing at all. In other 
words, the real or market value of stock is not the same as its 
par value except by accident. It may be either greater or less. 
The real value of the share is that for which it sells in the 
open market, and that is determined by the public’s appraisal 
of its worth as determined by a variety of factors—the tangible 
assets of the corporation, its earnings, its prospects, its undi¬ 
vided surplus, etc. 


THE CORPORATION 


33 


It is not necessary that all the shares be subscribed for or 
issued at the time the business is incorporated. A corporation 
may be organized with a capital stock only part of which has 
been subscribed for, the rest being held in reserve as unissued 
stock for future subscribers. But a certain proportion of the 
capital stock (usually small) must be subscribed for and paid 
in before the corporation can begin business. 

Full-Paid Stock 

Stock in the corporation may be issued to subscribers on 
any basis that the directors, with the assent of the stockholders, 
deem best. That is, it may be issued for its full face value in 
money, property, or services; or for only a portion of its face 
value, on partial payments, or as a gift. If, however, the full 
face value is not paid in money, property, or services, it is not 
full-paid stock, and consequently carries with it a stockholder’s 
liability to creditors of the corporation for the amount unpaid. 

Treasury Stock 

At the time a corporation receives its charter a certain 
percentage of its authorized capital stock generally remains 
unissued. This unissued stock represents nothing whatever 
beyond the potential right of issue reserved by the company. 
Consequently, unissued stock has no intrinsic value. This 
being so, the unissued stock cannot in any way be regarded 
as an asset of the corporation. 

Treasury stock, however, is stock that has once been issued 
for value and then reacquired by the corporation, and for the 

» 

time being held in its treasury subject to disposal by the direc¬ 
tors. So long as such stock is held by the corporation, it is 
inert and can neither be voted nor participate in dividends. 

It constitutes an asset on the books of the company, the value 
of it depending upon the intrinsic value of the corporate shares. 
The shares may be sold by the company below par to raise 
funds for corporate purposes, distributed among stockholders 


34 


TYPES OF BUSINESS ORGANIZATIONS 


as a bonus with preferred stock or bonds, or otherwise dis¬ 
posed of without subjecting the recipient to liability to cred¬ 
itors of the corporation, provided, of course, it was full-paid 
stock when originally issued. 

By-Laws 

When a sovereign (the state) creates a corporation, it 
grants the corporation by implication all powers necessary for 
carrying into effect the object for which it was created. It is 
therefore incidental to every corporation to have power to make 
by-laws and adopt regulations relative to the purpose for which 
it was created. Such a power is incidental when not specifically 
granted, and is subject only to the following restrictions: 

1. The by-laws must not be repugnant to the charter. 

2. They must not be contrary to public policy or opinion. 

3. They must be reasonable. 

4. They must not impair vested rights. 

The three primary sources of corporate regulation are, 
therefore: 

1. The corporate charter 

2. The by-laws 

3. The board of directors 

Once a charter is obtained, the corporation must adopt rules 
defining the rights of members, duties of officers, times of 
meetings, and other matters incidental to the proper govern¬ 
ment of the company. 

Function of By-Laws 

It is the function of the corporate by-laws to provide for 
such details of organization, administration, and business rou¬ 
tine as are not prescribed by and set forth in the charter. So 
far as the law is concerned, there is no legal necessity for 


THE CORPORATION 


35 


adopting by-laws, but the operation or functioning of a cor¬ 
poration without them would be practically impossible. 

The power to enact by-laws resides in the stockholders, 
unless the state statute confers it upon the directors. It would 
seem to be more properly vested in the stockholders as the 
constituent body of the corporation, but under some statutes 
the power has been given to the directors. In fact, when given 
them, this power to make by-laws constitutes one of the most 
important and effective rights of stockholders, because where 
restriction is to be placed upon the powers of directors, recourse 
is found in by-law provisions. 

By-laws usually prescribe the general organization of the 
corporation. Hence the adoption of a carefully prepared set 
of by-laws is, as a rule, one of the first important steps taken 
in the organization of a corporation. 

Scope of By-Law Regulation 

By-laws should provide fully for all the important details 
of corporate procedure, such as the issuance and transfer of 
stock, the meetings of the stockholders and directors, the elec¬ 
tion of directors and officers, together with the respective duties 
and responsibilities to be assumed by these officers, and the 
care and management of the corporate property and finances. 

The by-laws usually prescribe the means whereby any of 
the provisions may be repealed or amended—generally by a 
majority vote of a quorum of stockholders at any regular 
meeting or at a special meeting called for the purpose. Direct 
penalties are sometimes provided for the violation or non- 
observance of the by-laws. Such penalties, as a rule, take the 
form of fines. The more serious violations bring their own 
penalties in the legal liabilities that follow. 

Corporate Control—Stockholders 

The shareholders are those persons who have contributed 
capital to the enterprise and who are interested in the operation 


TYPES OF BUSINESS ORGANIZATIONS 


36 

of the company, inasmuch as their shares represent undivided 
interests in the corporate enterprise. They have no direct 
ownership in any of the property of the corporation; nor are 
they creditors of the corporation. They simply own the shares. 
The corporation holds the legal title to all the properties 
acquired, but it holds it for the pecuniary benefit of those 
persons owning the capital stock. They select the persons 
to manage its affairs; they also have the right to share in 
surplus earnings, and after dissolution they have the further 
right to have the assets reduced to money and ratably distrib¬ 
uted. Each share represents a distinct interest in the whole 
of the corporate property. 

In the active conduct of the business affairs of the corpora¬ 
tion, the stockholders do not directly participate. The actual 
management and the general control of the corporation is 
vested in the board of directors with whom the stockholders 
cannot directly interfere. 

Directors 

The board of directors (a distinction must be drawn be¬ 
tween the directors as individuals and the directors acting as 
a board) has sole charge of the business of the corporation and 
the control of its property. It is the managing body of the 
corporation. The powers of the board do not, however, extend 
beyond the purposes for which the corporation was formed. 
For example, they cannot sell the entire corporate assets, or 
mortgage the corporate property, without the consent of the 
stockholders. Their authority is still further restricted by the 
by-law provisions. The authority of the directors may be exer¬ 
cised only as a board in meeting assembled and with a quorum 
present. 

Directors of a corporation are virtually trustees for the 
body of stockholders, and must exercise the same degree of 
care and diligence in the conduct of the corporate affairs as 
prudent business men in the conduct of their own affairs. 


THE CORPORATION 


37 


In order to obviate the necessity for frequent meetings of 
the board and to secure prompt and decisive action on questions 
that arise, the board generally has power to appoint standing 
committees, such as an executive committee and a finance com¬ 
mittee. It is the duty of these committees to act and then 
report to the board. In event the committee desires to shift 
the responsibility back to the board, they will report the matter 
to the board with a recommendation that the desired action be 
taken. 

Officers 

Besides these standing committees, the board can act only 
through the officers and agents which it appoints. The usual 
executive officers of a corporation are a president, vice- 
president, treasurer, and secretary, any two of which may be 
held by the same person if the duties are not incompatible. 
The officers of the company carry out the instructions of the 
board, and have no independent powers or authority outside 
the duties and privileges given them by the by-laws. 

Corporate Finances 

The treasurer is the fiscal agent of the corporation. He 
has charge of its funds, securities, and general assets. The 
disbursement of the corporate funds is usually made under 
carefully prescribed conditions in the by-laws. As a rule, they 
provide that payments shall be made by the treasurer in accord¬ 
ance with the instructions of the directors. The treasurer 
usually countersigns all obligations issued by the corporation 
in the form of contracts, checks, notes, and, in general, han¬ 
dles its money and negotiable paper. 

Legal Liability of Corporation 

In the first place, a corporation can legally enter into and 
carry out only such acts as it is either expressly or impliedly 
authorized to perform by its charter. 


38 


TYPES OF BUSINESS ORGANIZATIONS 


By “implied powers” is meant powers necessary to cariy 
out its express powers, and not powers to engage in some col¬ 
lateral enterprise only remotely connected with the corporate 
purpose. The word “necessary” is used here not in the sense 
of being indispensable, but obviously appropriate, needful, 
suitable, and proper to accomplish the purpose for which the 
company was incorporated. 

Any acts in excess of its charter powers, either express or 
implied, are ultra vires (beyond its power). However, the 
legal consequences of such ultra vires acts vary. In the 
state courts a party to an ultra vires contract which has not 
been performed (an executory contract) may always set up 
the want of corporate capacity as a defense to being held liable 
on the contract. But the law will not interfere with a per¬ 
formed or executed contract, even though there was a lack 
of corporate capacity to enter into it. In applying the doctrine 
of ultra vires in the federal courts, however, the rule is that 
the contract of a corporation which is ultra vires is absolutely 
void and of no legal effect. Where there has been a part per¬ 
formance of such a contract, the party who has performed his 
part cannot sue on the contract, but can recover in quasi-con¬ 
tract on the basis of unjust enrichment. In New York, when 
there has been a part performance and the parties cannot be 
restored to their original status, the courts will enforce the 
entire contract. 

Stockholders’ Liability 

The interest, control, and management of a corporation are 
vested in: (i) the stockholders, (2) the board of directors, 
and (3) the officers, but the nature of their respective legal 
liability is quite different. 

In most states a stockholder is liable only for corporate 
debts only up to the face value of his holdings; so if the face 
value of his stock has been paid for in full his liability ceases 
and he is no longer responsible for the corporate indebtedness. 


THE CORPORATION 


39 


On the other hand, if a corporation becomes insolvent, the 
holder of stock not fully paid for is directly liable to the cor¬ 
poration, and indirectly to its creditors, up to the face or par 
value of his stock. 

In order to illustrate the legal significance of this doctrine, 
let us assume, for example, that a corporation is incorporated 
for $50,000, and has issued all of its stock, but only 50 per 
cent of the par value has been paid in. Unexpected losses 
coupled with inefficient management result in an almost com¬ 
plete loss of this $25,000. There is still $25,000 due from the 
stockholders which may be called in by the directors at any 
time. Let us assume, however, that they refuse to call it in. 
The creditors of that corporation, after having reduced their 
claims to judgment, can file a bill in a court of equity against 
the stockholders of the company and the court will decree that 
each of the stockholders holding share certificates which have 
not been paid for in full shall pay a pro rata share thereof, 
or a sufficient part to satisfy the claims of the plaintiffs, or 
judgment creditors. 

There are exceptions to this rule in several states. Thus, 
in Minnesota a stockholder is liable to creditors, in case the 
corporation becomes insolvent, for a further amount equal to 
the par value of his stockholdings. This is an important ex¬ 
ception to be taken advantage of by credit men in handling 
claims against insolvent companies incorporated under the laws 
of Minnesota. In California each stockholder is liable for 
any portion of his subscription that is unpaid, and also for such 
proportionate part of the corporate indebtedness incurred dur¬ 
ing the period in which he was a stockholder, as his stock bears 
to the total capitalization of the corporation. 

A stockholder has not an attachable interest in the property 
of a corporation. The corporation as such has full title and the 
sole legal interest in all its property, and the individual members 
of the corporation are not the owners of the corporate property. 
A share of stock represents a mere right of membership in a 


40 


TYPES OF BUSINESS ORGANIZATIONS 


corporation, which, however, may be attached by serving a 
writ of attachment on an officer of the corporation at its 
main office, who will make record thereof on the corporate 
records. 

Directors’ Liability 

The directors of a corporation occupy a fiduciary relation 
with respect to the stockholders quite analogous to the relation 
that exists between a trustee and the beneficiary. In fact, the 
directors are often said to be “quasi-trustees” of the corporate 
property for the benefit of the stockholders, and they are there¬ 
fore held to the exercise of the highest degree of fidelity in 
all dealings involving the rights of stockholders. Upon the 
dissolution of a corporation the directors become trustees for 
the creditors of the corporation. 

Under the common law the directors are personally liable 
for loss or damage resulting from ultra vires acts, or for acts 
exceeding the authority given them by the corporate charter, 
for any unlawful corporate act committed with their con¬ 
nivance, knowledge, or assent, for issuance of unpaid or partly 
paid stock as full paid, for the unlawful payment of dividends, 
and for any other gross mismanagement. They are not, how¬ 
ever, responsible for the results of errors of judgment in their 
management of the ordinary affairs of the corporation. 

Further liability has been placed on corporate directors in 
some states by statutory enactment, making the directors crim¬ 
inally liable under the laws against fraud, larceny, and embez¬ 
zlement. A dissenting director can always relieve himself from 
legal responsibilty by taking exception to such action and hav¬ 
ing his protest incorporated in the minutes. 

i 

Officers’ Liability 

It is commonly thought that the president and other offi¬ 
cers of a corporation have very extensive powers, but this 
is not necessarily so, as they have only such powers as are 


THE CORPORATION 


4* 

vested in them by the board of directors. Consequently, an 
officer contracting for his corporation within the limits of his 
authority is merely acting as a corporate agency, and, in the 
absence of fraud or deceit, does not bind himself and cannot 
be held personally liable in any way. If, however, he exceeds 
his authority, he renders himself personally liable, unless the 
corporation later ratifies his action, in which case he is released 
from further liability. 

A corporation may act per se through its own administra¬ 
tive officers, its inherent agencies, or per alium, through its 
especially appointed agents. Corporate officers are the agencies 
of the corporation. They are not agents of the corporation 
and their acts are not governed by the law of principal and 
agent. When the officers act in behalf of the corporation in 
their official capacity, the act done is one of the corporation 
per se and not per alium. On the other hand, when the offi¬ 
cers of a corporation create a liability on the part of the cor¬ 
poration by virtue of an authorization to that effect by the 
board of directors, they act as agents of the corporation, and 
not as the mere instrumentality through which the corporation 
itself acts. 

Officers are bound to use ordinary care and diligence in 
the conduct of the corporate business, and are therefore liable 
for any losses resulting from neglect, mismanagement, or 
wrongdoing in the discharge of their official duties, though not 
for any error of judgment. 

Corporation Reports 

The statutes generally provide that a stock corporation 
shall make an annual report of its affairs and file the same in 
some public office where any person may inspect it. The pur¬ 
pose of this is to enable persons who may wish to do business 
with the corporation to ascertain its financial condition. The 
report usually contains a statement as to the amount of capi- 


42 


TYPES OF BUSINESS ORGANIZATIONS 


tal stock outstanding and amount of the assets and liabilities. 
Some state statutes make the directors’ personally liable for 
debts in case they fail to file such a report, and also for debts 
contracted upon the faith of the report filed in case it is false 
in any material particular. 


PART II 


LEGAL NATURE OF SALES 



CHAPTER IV 

SALES AND SALES CONTRACTS 


Essential Knowledge 

It is also essential that a credit man should have a clear, 
correct conception as to the precise nature of the legal obli¬ 
gations he is trading in and the legal rights and remedies that 
arise in the sale of merchandise. This chapter is therefore 
devoted to a brief but, in so far as mercantile credit is con¬ 
cerned, a sufficiently complete discussion of the legal aspects of 
commercial sales and contracts to sell. 

In the first place, there is a common basis for all the legal 
rights and remedies of a mercantile creditor, whether whole¬ 
sale or retail, and that is the fact that they all arise out of 
and result from the sale of goods, wares, and merchandise. 
And in so far as the legal aspects of his work are concerned, 
a credit man has to deal mainly with contracts involving the 
sale of goods, and the enforcement of obligations resulting 
from and growing out of the actual sale of goods. Conse¬ 
quently, he needs to know what constitutes a binding contract 
of sale, what obligations and rights result therefrom, and 
what steps are necessary to its legal performance. It will, 
therefore, be the object of this chapter to state and explain 
the application of some of the most important legal principles 
that have been established in this connection. 

Legal Distinction between Sales and Contracts to Sell 

All legal contracts begin with an agreement, by which is 
meant a meeting of the minds of the contracting parties in a 
common assent to the same set of facts. This agreement is of 
a twofold nature in that it may be such as actually to trans- 


45 


46 


LEGAL NATURE OF SALES 


fer a present right and title to goods, or as only to create an 
obligation to transfer the right and title to goods at some fu¬ 
ture time. In other words, the agreement may partake of the 
nature of a sale or only a contract to sell. There is an impor¬ 
tant distinction to be made between the two, and the legal 
rights and remedies arising therefrom are quite different. The 
principal distinction is that a sale (Form i) is a completed 
transaction, wherein the ownership of the goods has passed 
from the seller to the buyer, even though the seller may still 

Sales Agreement 

This agreement certifies that I, Herman A. Riddell, of Augusta, 
Georgia, have this day bargained and sold to James C. Swift, of Elberton, 
Georgia, the Four Hundred (400) bushels of wheat now stored in my name 
in the Bussey Warehouse #86 Greene Street, Augusta, Georgia, delivery to 
be taken as needed within sixty (60) days from date. 

And in consideration for which said James C. Swift hereby agrees 
to pay said Herman A. Riddell the sum of five hundred dollars ($500) 
within thirty days from date. 

Signed: 

Herman A. Riddell 
James C. Swift 

November 10, 19— 

Form 1. A Sale 


retain possession of the goods and the price may not have 
been paid at the time the sale was consummated; whereas a 
contract to sell (Form 2) means that the ownership of the 
goods is to be transferred at some future time. 

Contract to Sell 

This agreement made and entered into this tenth day of November, 
19—, between Alex G. Drury, of Cincinnati, Ohio; and William Carpenter, 
of the same place. 

Witnesseth, that the said Alex G. Drury hereby agrees to sell and 
deliver to the said William Carpenter, five hundred (500) bushels of wheat, 
of good marketable quality, on or before the twenty-fifth day of November, 
at his warehouse located at # 86 West Fourth Street, Cincinnati, Ohio. 

And, that the said William Carpenter in consideration thereof hereby 
agrees to pay the sum of sixty cents per bushel for the said wheat upon 
the completion of the delivery thereof. 

Signed: 

Alex G. Drury 
William Carpenter 

November 10, 19— 

Form 2. A Contract to Sell 


SALES AND SALES CONTRACTS 


47 


However, a letter containing an offer which is accepted by 
another letter is the simplest and most common form of con¬ 
tract to sell. The. offer may be made as follows : 

Dear Sir: 

Our company has on hand some 30 or 40 tons of nut and 
bolt scraps which we shall be pleased to sell at $1.30 per hundred¬ 
weight, terms 30 days, and deliver in Winton Place within five 
days after order. We will sell in lots of not less than 10 tons. 

Kindly advise at your earliest convenience if you desire any 
or all of this material. 

Yours very truly, 

The acceptance of this offer may be made thus: 

Gentlemen : 

In reply to your letter of., I shall be pleased to 

take 15 tons of the nut and bolt scraps you describe, at the 
price and subject to the terms named, provided same is delivered 
on or before the .... of this month. 

Yours very truly, 

The following distinction between a sale and a contract to 
sell is made in the Uniform Sales Act: 

A sale of goods is an agreement whereby the seller transfers 
the property in the goods to the buyer for a consideration called 
the price. 

A contract to sell goods is a contract whereby the seller 
agrees to transfer the property in the goods to the buyer for a 
consideration called the price. 

The importance of this distinction becomes readily appar¬ 
ent when it is pointed out that where the goods have been 
actually sold and the buyer makes default, the seller may sue 
for the contract price; but where an agreement to sell is broken, 
the seller’s remedy is an action for unliquidated damages re¬ 
sulting from the breach of contract. 

Requisites of a Sales Contract 

In order that a contract shall be enforcible, that is, one for 
the non-performance of which the law will give damages, it 



48 


LEGAL NATURE OF SALES 


must comply with the following requisites. There must have 
been: 

0 

1. Mutual assent, 

2. By competent parties, 

3. Upon adequate consideration, 

4. For a legal object, and 

5. It must have been made without mistake, fraud, or 

undue influence. 

1. Mutual Assent 

It is essential that the parties to a contract should agree on 
the terms, or, in legal phraseology, that “there should be a 
meeting of minds.” This agreement results usually from an 
offer made by one party and accepted by the other. The offer 
may be oral or written, except as qualified by compliance with 
the Statute of Frauds. (See page 54.) The simplest form 
of contract consists of an offer to sell goods at a specified 
price and an acceptance of the goods at that price. If the offer 
is made by letter and the acceptance is made by letter, the two 
letters taken together constitute a complete contract of sale, 
provided the acceptance is in the same terms as those in which 
the offer was made. To accept an offer in any terms other 
than those in which the offer was made amounts to a refusal 
to accept the offer as tendered. When nothing is said in the 
offer as to the manner of payment the law implies cash. When 
nothing is said about the time for delivery the law implies 
that the buyer is to be entitled to delivery of the goods upon 
payment of the price. 

It is but larely that the parties to a contract express their 
assent simultaneously. Nearly always such an agreement is 
arrived at by a process of offer and acceptance of terms. If the 
offer is made by mail or telegraph, the post office or telegraph 
company becomes the agent of the seller to receive the accept¬ 
ance of the buyer, and the contract becomes binding the mo¬ 
ment a correctly addressed letter of acceptance is deposited in 


SALES AND SALES CONTRACTS 


49 


the mail box, even though it should fail to reach its proper 
destination; or the moment a prepaid telegram, properly ad¬ 
dressed, is given to the telegraph company for transmission 
to the seller. Prior to such acceptance by the buyer the seller 
has a right to revoke or withdraw his offer, provided he actually 
notifies the other party of his withdrawal before the other 
party has accepted his offer. 

If an offer is made by mail or telegraph the acceptance 
must be communicated through the same medium in which 
the offer was received. If, on the contrary, a different agency 
is used, there is no contract until the acceptance has actually 
been received by the seller. It therefore follows that if the 
seller makes an offer by wire, which the other party accepts 
by mail, the seller may revoke his offer at any time prior to 
receipt of the letter of acceptance; whereas if the original 
offer had been made by mail, the mail acceptance would have 
constituted a binding contract upon mailing. 

If an offer is made to one person, no other person can 
accept it. Likewise, if made for only a limited time, it must 
be accepted within that time. Where no time limit is speci¬ 
fied the offer must be accepted within a reasonable time. What 
constitutes a reasonable time depends upon the nature of the 
circumstances attending it, and of the commodity or subject 
matter of the offer. 

2. Competency of Parties 

With certain exceptions all persons are able to enter into 
binding contract relations. Contracts made during infancy are 
voidable at the infant’s option and subject to disaffirmance 
upon his becoming of age. (In other words, an infant—mean¬ 
ing a person under 21 years of age—continues to be trouble¬ 
some legally even after he has ceased to be troublesome as a 
child.) However, an infant’s contracts are binding upon the 
adult with whom they are made. Likewise, if one contracts 
with an insane person, knowing him to be insane, the contract 



50 


LEGAL NATURE OF SALES 


is voidable by the lunatic. There is one exception to this 
general rule qualifying the contractual capacity of infants and 
insane persons—a merchant may supply either one with abso¬ 
lute necessities for life and health, and will be legally entitled 
to payment for them. 

At common law married women were incapable of making 
binding contracts, but this disability has since been removed by 
statutory provisions in the different states, and as a rule mar¬ 
ried women today possess the same contractual capacity as 
unmarried women. But it is always advisable to consult the 
law of the state in which the contract is to be entered into 
before entering into a contract with a married woman, as a 
few states still restrict the measure of her legal responsibility. 

3. Consideration 

A mere promise to do or to give something is not in and of 
itself enforcible by law. Some consideration must be given for 
the promise by the other party to make it legally binding. This 
generally consists in some legal detriment suffered by the 
promisee, the party receiving the promise, in relying upon the 
other’s promise, and there is usually some corresponding bene¬ 
fit to the promissor, the party giving the promise. In other 
words, mutual promises constitute adequate consideration on 
the part of both parties, by which is meant that if one party 
makes a promise in return for another’s promise, the law will 
compel him to carry out his promise when the first party has 
fulfilled his. 

The law allows persons to affix their own value to their 
respective promises, and the consideration need not equal in 
value the promise in return for which it is given. It may be 
very small in comparison with the value of what is agreed to 
by the other party. In fact it is a common practice in draw¬ 
ing up contracts and bills of sale merely to specify the sum of 
$i where the parties do not wish to disclose the full amount 
of the consideration. 


SALES AND SALES CONTRACTS 


51 


It may be stated that, as a rule, if the promisee does, or 
forbears from doing, anything he is not legally bound, or 
forbidden to do, this in itself is sufficient consideration. If, 
however, the consideration agreed to by one of the parties is 
something impossible to perform, the contract is void and un- 
enforcible, for he could not be required to perform it and 
consequently has given nothing. Likewise, the doing of some¬ 
thing one is already obliged to do is not a valid consideration, 
because no additional legal liability is thereby incurred. For 
example, a promise to settle a past-due account would not be 
a good consideration for some new sales agreement. 

4. Legality of Object 

A contract to do anything contrary to law would be unen- 
forcible, and there are a very considerable number of instances 
(varying in the different states) in which contracts are held 
to be illegal because contrary to public policy. Only the few 
of especial interest to the credit men will be enumerated. 

Gambling Contracts, wherein one party sells goods to an¬ 
other for future delivery at a specified price, but in fact neither 
party intends an actual delivery of the goods to be made, but 
rather a settlement in money on the delivery day, are illegal, 
inasmuch as it is the equivalent of betting as to what the mar¬ 
ket price for that particular commodity will be on a certain 
day. It corresponds to what is known among security-brokers 
as “bucket shopping.” 

Contracts for the Sale of Adulterated Goods are forbidden 
and made illegal by the Pure Food Law, which is supplemented 
by special statutory provisions enacted in the different states. 
Being made illegal, such contracts are, of course, unen- 
forcible. 

Contracts in Restraint of Trade may be legal or illegal de¬ 
pending upon whether the restraint is reasonable or unreason¬ 
able. Under the Clayton Law whether a discrimination in 
price between different purchasers of commodities or an exclu- 


52 


LEGAL NATURE OF SALES 


sive purchase and sale arrangement is illegal, depends upon 
whether its “effect” may be to substantially lessen competition 
or to create a monopoly. In other words, the Clayton Law 
renders it exceedingly difficult for a person engaged in mercan¬ 
tile trading to tell in advance whether, if he shall discriminate 
in price between purchasers or make an exclusive purchase and 
sale arrangement, he will thereby violate the law, because he 
cannot foresee what ultimate effect upon competitive trade and 
monopoly his conduct may have. 

Agreements on the part of producers and manufacturers 
to fix the resale prices of retailers, have been held to be in 
restraint of trade and void, even in the sale of goods manu¬ 
factured under a secret process. 

5. Mistake, Fraud, and Undue Influence 

Legal contracts result from the meeting of minds of the 
contracting parties, and if either or both parties consent by 
mistake, or are misled by some misrepresentation or fraud, 
or are compelled to consent by duress or undue influence, such 
contracts may later be avoided by the party misled. On the 
other hand, there is a legal maxim to the effect that “ignorance 
of the law excuses no one,” meaning that the mere fact that 
an illegal contract has been entered into in good faith does 
not suffice to excuse a man when he later learns of its 
illegality. 

(a) Mistake. There are two kinds of mistakes possible 
in making a contract: 

(1) A mistake as to the subject of the contract, namely: 

Its existence. 

Its identity. 

Its quality. 

(2) A mistake as to features of the contract other than 

the subject matter: 

The party with whom one is dealing. 

The terms of the agreement. 


SALES AND SALES CONTRACTS 


53 


A mutual mistake as to the existence of the subject matter 
of the contract prevents any contract from being entered into. 

Example: A sells B a cow. Unknown to either party the 
cow had died prior to the contract being entered in to. No con¬ 
tract has been entered into because there was no cow in exis¬ 
tence to constitute the subject matter the parties had in 
mind. 

A mistake as to the identity of the subject matter enables 
either party to avoid the contract. 

Example : A had two Packard automobiles, one a touring car 
and the other a roadster. B purchased the touring car and 
offered to sell A’s Packard to C for $2,000. C, believing A to 
own only the roadster and thinking it was the one to which B 
referred, accepted the offer. There is no binding contract, 
because the minds of B and C did not meet on the same sub¬ 
ject matter. 

A mistake as to the quality of the goods does not ordinarily 
suffice to avoid the contract. 

Example: A purchased a quantity of second-grade wheat 
from B at 30 cents a bushel and resold this same wheat to C at 31 
cents a bushel. Later A learned that the wheat was first-grade 
quality, worth 40 cents a bushel, and wished to avoid his con¬ 
tract with C. The contract is binding. 

A mistake as to the identity of the party with whom one 
is dealing will avoid a contract. A party cannot be forced into 
an agreement with someone with whom he did not intend to 
contract. 

Example: A has been doing business for years at a certain 
address with B. Unbeknown to A, B has sold out his business 
to C, who continues to carry on the business under the' same 
name. C sends an offer for goods to A which is accepted, and 
shipment is made, but before the goods are delivered A learns 
of the change in proprietorship and stops the shipment in transit. 
There was no binding contract. A has a right to select whom 
he will deal with and is not obliged to recognize strangers under 
such a mistaken identity. 


54 


LEGAL NATURE OF SALES 


If an error is made in the terms of the agreement so that 
it misrepresents the actual agreement intended to be entered 
into by the parties, such an error does not necessarily avoid 
the contract, and it may be enforced according to the terms 
actually intended. 

Example : A owns a 6-cylinder Buick automobile which he 
contemplates trading into B, a used-car dealer. B in turn tells 
C of the contemplated deal “for A’s 4-cylinder Buick.” C has 
ridden in the car with A and agrees to purchase it from B for 
$900. Later both B and C learn that it is a 6-cylinder car. 

The contract is binding as there was a meeting of minds on the 
particular Buick owned by A, whether it had 4 or 6 cylinders. 

(b) Fraud. Fraud consists in a false representation of 
fact, knowingly and intentionally made with the intention 
that it should be acted upon by another, and actually acted upon 
to the other party’s damage. If there is any such fraud in 
inducing a party to enter into a contract, he may refuse to 
perform his part of it. If the contract is carried out before 
the fraud is discovered, the seller may later recover his goods 
or their value. He may also let the contract stand and sue for 
damages covering any loss he may have suffered. 

Misrepresentation of fact may take the form of collateral 
promises and become express warranties, for the breach of 
which recovery may be had at law (see page 77). 

(c) Undue Influence. Contracts must be entered into 
freely and voluntarily. A person must consent to a contract 
of his own free will. Consequently, where there has been an 
unconscientious use of power by one over the will of another, 
whereby the latter is induced to make contracts he otherwise 
would not enter into, such contracts are void and unenforc- 
ible. Instances of this nature, however, are comparatively 
rare and seldom arise in the work of a credit man. 

Statute of Frauds 

Practically every state has enacted some special statute re¬ 
quiring certain formalities to be complied with in the incur- 


SALES AND SALES CONTRACTS 


55 


rence of certain obligations as a necessary precaution against 
the perpetration of fraud, or the possibility of mistake as to 
the terms of the transaction. This statute is generally termed 
the “Statute of Frauds.” 

Section 17 of the English Statute of Frauds, which is the 
one adopted by most states, provides that contracts for the 
sale of goods, wares, and merchandise of the value of $50 or 
more, must be evidenced either: (1) by the acceptance and 
receipt of the goods, or a part of them, or (2) by the payment 
of some part of the purchase price, or (3) by some note or 
memorandum in writing signed by the party to be charged or 
his authorized agent. 1 

In other words, under this section of the statute you cannot 
charge a buyer on a sale amounting to $50 or over, unless there 
has been a part delivery, part payment, or a memorandum 
signed by the buyer or his authorized agent. 

Memorandum of Sale 

. In the latter case the memorandum (Form 3) may be in 
any form, but it must contain three elements: 

1. Names of the contracting parties. 

2. Description of the subject matter of the transaction. 

3. Terms of the agreement. 

1. The Names of the Contracting Parties. The 
memorandum should identify the parties and show the rela¬ 
tionship of buyer and seller. However, it need not be signed 
or subscribed by both parties; it is enough that the one who 
is sought to be charged has signed it. 

Example: A sells B 1,000 bushels of wheat at $1 a bushel. 

B signs the memorandum but A does not. A may maintain an 

1 This section of the English Statute of Frauds, with slight changes, has been enacted in 
most of our states, the exceptions being Alabama, Arizona, Delaware, Illinois, Kansas, Ken¬ 
tucky Louisiana, New Mexico, North Carolina, Ohio, Pennsylvania, Rhode Island, Tennessee, 
Texas' Virginia and West Virginia. The limitation as to the amount varies, however, from 
$30 in Missouri, Arkansas, and Maine, to $2,500 in Ohio; whereas m both Florida and Iowa 
all transactions for the sale of goods of whatever value are within the statute. Arizona, Illi¬ 
nois, Ohio, Pennsylvania, Rhode Island, and Tennessee have since enacted the Uniform Sales 

Act. 



56 


LEGAL NATURE OF SALES 


action against B in case he refuses to accept the wheat, but B 
could not maintain an action against A in case he refused to 
deliver it. 

It is therefore advisable that both parties should sign 
because of the uncertainty as to which party may seek to 
avoid the performance. An authorized agent may sign for 
either party. 

Memorandum of Sale 

The Kemper-Betts Commission Company 
263 Parker Street, Cincinnati, Ohio 

November 10, 19— 

We have this day sold to Charles S. Lee, 2363 Wold Ave., Cin¬ 
cinnati, Ohio, the following goods: 

25 tierces of Crisco at $37.50 per tierce 
delivery to be made as called for within 30 days 
terms, 30-1-10. 

The Kemper-Betts Commission Company 
Gilbert L. Kemper, Treasurer 
Charles S. Lee 
Form 3. Memorandum of Sale 

2. Description of the Subject Matter. The goods 
to which the sale or contract to sell relates must be described 
in the memorandum to such an extent as to identify clearly 
and with sufficient certainty the subject matter of the agree¬ 
ment. This has been construed to mean that the description 
may be too brief, or it may be worded in such technical terms 
that the meaning is not apparent to an uninstructed person, 
but this does not necessarily signify a non-compliance with 
the statute when the meaning can be shown by parol evidence. 
Whether a memorandum written entirely in cipher and wholly 
untranslatable without parol evidence is a good memorandum 
within the meaning of the statute, Professor Williston, of the 
Harvard Law School, says, has never been decided. 

3. The Terms of the Agreement. The writing should 
contain all the terms of the contract clearly specifying the price 
and terms of payment (if these have been decided upon by 
the parties), as well as all other material facts and conditions 
pertaining thereto. In other words, the weight of authority 


SALES AND SALES CONTRACTS 


57 


is to the effect that the memorandum must contain substantially 
the whole agreement and all the material terms and conditions, 
so that one reading it can understand from it what constitutes 
the agreement. 

Purchase of Several Articles 

Whether or not the purchase of a single article at a fixed 
price is within the Statute of Frauds is readily determinable. 
But suppose the subject matter of the purchase consists of 
several articles the price or value of each being under the 
statutory limit, yet the total amount of all taken together is 
in excess of this limit. No definite ruling has been established 
to cover this point, and, while the question has frequently 
arisen, the decisions have turned on the particular circum¬ 
stances of the case in issue. If any general rule or principle 
can be laid down in this connection, it is that the test in such 
cases, as to whether a given transaction comes within the 
statute, is whether the contracting parties intended to enter 
into separate and distinct contracts with regard to each single 
article, or to make one entire contract for all of the articles. 
In the former case it would not, and in the latter case it would, 
come within the statute. 

Statutory Exclusions 

In construing this provision in the Statute of Frauds a 
distinction is made between a contract of sale and a contract 
for work and labor, the significance of the distinction being 
that in the case of the former it must comply with the statute, 
whereas the latter has been held not to come within the statute. 

Example: A orders B, a shoe manufacturer, to make up for 
him 1,000 pairs of shoes of certain description, for which A 
agrees to pay $4,000 when the shoes are made up. A later 
refuses to accept them, and pleads the Statute of Frauds. The 
question then arises: Was this a contract of sale? If so, B can¬ 
not recover against A because there has been no receipt of goods, 
no part payment, and no memorandum in writing. If, on the 


58 


LEGAL NATURE OF SALES 


other hand, it is a contract for work and labor, B may recover 
against A because such a contract is not within the Statute of 
Frauds and is therefore good even though it was not reduced 
to writing. 

In those states where the Uniform Sales Act has been 
enacted, the subject is fully covered in section 4, which pro¬ 
vides : 

m 

(1) A contract to sell or a sale of any goods, or choses ii 
action of the value of five hundred dollars ($500.00) or upwards, 
shall not be enforceable by action unless the buyer shall accept 
part of the goods or choses in action so contracted to be sold, 
and actually receive the same, or give something in earnest to 
bind the contract, or in part payment, or unless some note or 
memorandum in writing of the contract or sale be signed by the 
party to be charged or his agent in that behalf. 

(2) The provisions of this section apply to every such con¬ 
tract or sale, notwithstanding that the goods may be intended 
to be delivered at some future time or may not at the time of 
such contract or sale be actually made, procured or provided, 
or fit, or ready for delivery, or some act may be requisite for the 
making or completing thereof, or rendering the same fit for 
delivery; but if the goods are to be manufactured by the seller 
especially for the buyer, and are not suitable for sale to others in 
the ordinary course of the seller’s business, the provisions of 
this section shall not apply. 

(3) There is an acceptance of goods within the meaning of 
this section of the Uniform Sales Act when the buyer, either 
before or after delivery of the goods, expresses by words or con¬ 
duct his assent to becoming the owner of those specific goods. 

Acceptance and Receipt of Part of the Goods 

Acceptance may be said to involve a mental state or con¬ 
dition rather than an act, although an' act may be relied upon 
as evidence to prove the mental state. To constitute such an 
acceptance, says Irving Browne in his work on the Statute of 
Frauds, “there must be such conduct on the part of the buyer 
in respect to the goods as affords evidence that he has identi¬ 
fied and recognized them as the goods which were to be his 


SALES AND SALES CONTRACTS 


59 


by virtue of the alleged contract.” It has no necessary rela¬ 
tion to the actual receipt of the goods, and “if the contract 
be for specified goods, the acceptance takes place at the time 
of the bargain, and the same evidence which proves the bargain 
will also prove an accceptance.” 

The term “receipt” relates to the transfer of possession 
of the goods as distinguished from the transfer of title to the 
goods. According to Browne : 

The actual receipt of the goods does not necessarily involve 
a manual taking of possession of them by the buyer. In many 
cases this would be impracticable, and no other receipt is re¬ 
quired than such as is consistent with the nature, locality, and 
condition of the goods. Though this be merely symbolical, the 
statute will be satisfied when the case admits of none other. 

It is, therefore, a general rule in regard to the actual receipt of 
inaccessible, ponderous, or bulky articles that it may be accom¬ 
plished by the performance of any act which shows that the seller 
has parted with the right to control the property, and that the 
purchaser has acquired that right. 

Actual acceptance and receipt of part of the goods, however 
small, will suffice to satisfy the statute if the part or sample 
is accepted and received as part of the lot of goods sold or con¬ 
tracted to be sold. On the other hand, if at the time the buyer 
accepts and receives part of the goods he declines to accept 
any more, the statute is not satisfied, because the buyer does 
not accept and receive same as only a part of the whole. 

Part Payment 

A payment not made at the time the bargain is entered 
into cannot under any circumstances satisfy the requirements 
of the statute. But when a valid contract for the sale of goods 
is entered into and the buyer later pays a part of the purchase 
price expressly to bind the contract, or when payment is made 
and the parties reaffirm or restate the terms of the contract, 
the statute is undoubtedly satisfied, because such payment is 
then made “at the time of the contract” and not afterward. 


6o 


LEGAL NATURE OF SALES 


Effect of Non-Compliance 

The legal effect of non-compliance with this statute is not 
uniform in all jurisdictions. In the first place, if it is not set 
up as a defense to the action, oral evidence of the agreement 
is admitted in most jurisdictions. It has also been held in 
some jurisdictions that where a memorandum of the trans¬ 
action was obtained after the making of the agreement but 
before the commencement of the action, the statute is satisfied. 
It therefore seems preferable, as one writer has said, to hold 
that the statute has to do with certain prerequisites to the 
bringing of an action rather than with certain methods of 
proof. In other words, the statute operates as a rule of pro¬ 
cedure, and in this respect is analogous to a Statute of Limita¬ 
tions which prohibits the plaintiff from enforcing a right of 
action unless he begins his suit within a certain period. 2 

If the original contract is and had to be in writing under 
the Statute of Frauds, all modifications of it must likewise 
be in writing. 


2 See Schaub and Isaacs, The Law in Business Problems, p. 193 . 



CHAPTER V 


THE PASSING OF TITLE 

Importance of the Time of the Passing of Title 

Perhaps the most important phase of the law of sales 
has to do with the passing of title, because on it depends the 
legal rights created by the parties at the time the transaction 
is entered into, and the determination as to whether or not 
the risk of loss has been shifted from the seller to the buyer. 
Furthermore, if title has passed the goods are subject to attach¬ 
ment by creditors of the buyer, and the seller may maintain an 
action for the purchase price of the goods; whereas, as has 
previously been pointed out (see page 47), if title has not 
passed, the seller’s action would be for damages for breach of 
contract. 

Although it is important to ascertain the time when title 
passes from the seller to the buyer, the precise nature of the 
relation created between the parties is oftentimes difficult to 
determine, because in the absence of fully expressed and 
specified terms of sale it is the implied intention of the parties 
that governs. 

Example: A sells B $5,000 worth of lumber, and it is agreed 
that the following day A is to have it assorted into grades, 
ready for shipment to different points according to grade. That 
night the lumber is destroyed by fire, and the question arises 
as to which of the parties shall bear the loss. Nothing was said 
or agreed upon as to just when title to the property should shift 
from A to B, although the importance of this aspect of the 
transaction is, under the circumstances, obvious. 

The importance of such information to the credit man is 
readily apparent, because once a sale is made it eventually 

61 


62 


LEGAL NATURE OF SALES 


devolves upon the credit department to handle the collection 
of the purchase price, and it is first necessary to ascertain 
one’s legal rights in order to be in a position to handle such 
matters intelligently. Furthermore, it should not be neces¬ 
sary for an experienced credit man to pay an attorney for 
information which he can readily obtain for himself, and with 
which he should be familiar. 

Rules Governing the Intent of Parties 

In a contract to sell, the time at which title to the goods 
passes depends upon the intention of the contracting parties, 
provided such intention is manifest from the terms of the 
contract. In other words, the parties can agree to anything 
they desire with regard to when the title shall pass; but if 
they agree upon the price, terms of payment, place of payment, 
time of delivery, place of delivery, and everything except as 
to when title to the goods shall pass from the seller to the 
buyer, the law has laid down certain rules or principles deter¬ 
mining the implied intention of the parties when no clear inten¬ 
tion is manifest or expressed in the terms of the agreement. 

Rule i. Where there is an unconditional contract for the 
sale of specific goods in a deliverable condition, title to the 
goods passes to the buyer when the contract is made, even 
though payment or delivery or both is to be made at some 
future time. 

Example: A sells B a lot of lumber for $1,400 and it is 
agreed that the lumber shall be delivered the following week and 
paid for within 40 days. That night the lumber is destroyed by 
fire. Title was in B and he therefore must bear the loss—not 
the seller. 

Rule 2. Where there is a contract for the sale of specific 
goods, but the seller is obligated to do something to the goods 
to put them into a deliverable condition, title to the goods does 
not pass to the buyer until this has been done. 


THE PASSING OF TITLE 


63 


Example : A sells B a quantity of lumber and agrees to have 
it assorted into various grades for shipment to different manufac¬ 
turing points of B. That night the lumber is struck by light¬ 
ning and destroyed. B is not bound to pay the purchase price 
because title does not pass from A to B until the lumber has 
been assorted by A. 

This rule, says Professor Williston, of the Harvard Law 
School, seems to be founded in reason. In general, it is for 
the benefit of the seller that the property or title should pass, 
because the risk of loss is thereby transferred to the pur¬ 
chaser, and as the seller may still retain possession of the goods 
so as to retain a security for payment of the price, the trans¬ 
ference of the property to the seller is pure gain. It is there¬ 
fore reasonable that where by the agreement the seller is to 
do something before he can call upon the purchaser to accept 
the goods as corresponding to the agreement, the intention of 
the parties should be taken to be that the seller was to do this 
before he obtained the benefit of the transfer of the property. 

Rule 3. Where the subject matter of the sale consists of 
fungible goods (goods which upon being mixed together com¬ 
pletely lose their identity and are no longer susceptible to sep¬ 
aration into their component parts, such as oil, wine, wheat, 
etc.), title to a fractional part of the whole passes immediately, 
and the purchaser becomes a co-owner, or tenant in common. 

Example: A sells B 50 barrels of oil, constituting part of 
the contents of a tank containing 150 barrels—delivery to be 
taken by B in B’s tank car at any time within 10 days. That 
night A’s entire place of business is destroyed by fire. Title 
to of the contents of the tank passed to B at the time of the 
sale, and the loss is therefore B’s, not A’s. 

Some states, however, hold that where the measuring or 
weighing at the time of delivery is to be done by the seller in 
order to ascertain the price the buyer is to pay, title does not 
pass until this has been done. 

Rule 4. This rule is concerned with C. O. D. and approval 
sales as follows: 


6 4 


LEGAL NATURE OF SALES 


(a) Where goods are sold C. O. D. for local delivery, 

title does not pass until the goods have actually 
been delivered, the carrier in such instances act¬ 
ing as the agent of the seller. 

(b) Where goods are sold C. O. D. for delivery at a 

distance, title passes on delivery to the carrier, the 
carrier in such instances acting as agent of the 
buyer. In other words, a delivery to a carrier 
pursuant to the expressed or implied direction of 
the purchaser, is a good delivery to him. 

(c) Where goods are sold on approval, title does not 

pass until the goods are actually delivered and the 
buyer either indicates his approval or retains the 
goods an unreasonable length of time. 

Rule 5. If the agreement provides for delivery to the buyer 
at a particular place, title does not pass until the goods have 
reached the buyer or the place agreed upon. 

The fact that the seller is to pay the freight does not pre¬ 
vent title from passing to the buyer on delivery to the carrier. 
If the goods are sold “freight prepaid,” it does not necessarily 
obligate the seller to make delivery, and his responsibility ceases 
when he has delivered the goods to the carrier and obtained a 
receipted bill of lading. 

Right of Inspection in C. O. D. Sales 

Under ordinary circumstances, when a seller sells and ships 
goods of specified description, the buyer clearly has the right 
of inspection before acceptance. And if the goods are in 
accordance with the terms of the order, title passes at the mo¬ 
ment of shipment and the purchaser is bound to pay the price. 
On the other hand, if they do not fulfil the required conditions, 
the buyer need not accept them and there is no sale. 

But when goods are shipped C. O. D., do the same princi¬ 
ples apply? According to the better opinion the condition of 
collection on delivery does not prevent the passing of title 


THE PASSING OF TITLE 


65 

upon delivery to the carrier. As to its effect upon the right 
of inspection, however, the authorities are not in accord. 

It has been held that the carrier incurs no legal liability 
to the consignee for refusal to allow inspection. An express 
company, however, which allowed inspection was held not liable 
in an action brought by the seller. In this case the carrier had 
delivered the goods to the purchaser upon deposit of the pur¬ 
chase price, and had agreed to return the deposit if the goods 
proved unsatisfactory. 

There is a general rule, however, among express compa¬ 
nies not to allow inspection of goods sent C. O. D., and in 
cases where this method of shipment is contemplated the par¬ 
ties might well be taken to have agreed that this rule should 
form an implied element of the contract. After payment has 
been made and the goods obtained, if they should prove not 
to be in accordance with the order, the buyer would have the 
usual remedies for breach of the implied warranty that the 
goods conformed to the description. In some jurisdictions 
he could sue only for damages; in others, he would be allowed 
the option of rescission or damages. On principle he clearly 
should have this option, since he had no opportunity to inspect 
the shipment. 

Assuming the purchaser had not authorized the shipment 
of the goods C. O. D., he could not be taken to have contracted 
with reference to the rule of the carrier, and consequently his 
right of inspection would remain and such a consignment 
would therefore not constitute a valid tender. 1 

Delivery 

In a sale, delivery, which may be either actual or con¬ 
structive, is made at the time the sale is consummated. The 
delivery may consist in merely setting aside the goods, but the 
title passes just the same as though actual delivery of them 
had been made to the purchaser. In instances where con- 


lSee XVIII Har. Law Rev. 386, 



66 


LEGAL NATURE OF SALES 


structive delivery only has been made and the goods are later 
destroyed, title having passed, the loss is the purchaser’s. 

On the other hand, it is impossible to transfer the owner¬ 
ship of goods that have not been made specific. For example, 
a contract to sell io barrels of flour possessing certain specific 
qualifications does not transfer title to the flour until some 
specified io barrels have been designated as the subject matter 
of the contract. Usually the selection is made by the buyer, 
but in some cases the buyer directly or indirectly authorizes 
the seller to make the selection for him. 

Assent of Buyer to Passing of Title on Delivery to Carrier 

Delivery of goods to the carrier under a contract to sell 
ordinarily passes title to the buyer, but if the shipment is not 
strictly in accordance with the contract, the buyer must assent. 
In the absence of any contract, title could not pass until the 
time the buyer accepted the offer and assented to receive the 
title. 

Sales without Delivery 

There is always an element of risk involved in leaving 
goods in the seller’s possession, for this reason—if the seller 
is dishonest enough to resell the goods, there would be no right 
of recovery of the goods from any third party to whom they 
have been resold or pledged. 

This is certainly true of the states which have adopted the 
Uniform Sales Act, which makes a seller who has the goods 
left in his possession the agent of the buyer to sell, pledge, or 
otherwise dispose of them. This is also true of other states 
in which the Uniform Sales Act has not been adopted (Califor¬ 
nia, Colorado, Kentucky, Maine, Montana, Oklahoma, South 
Dakota, Vermont, and Washington). 

Although seemingly unjust on the surface, the doctrine is 
made necessary by the opportunity such a situation affords to 
mislead innocent third parties who, having no notice of the 


THE PASSING OF TITLE 


6 7 


previous sale, would therefore be justified in proceeding on 
the assumption that the property rightfully belonged to the 
seller. 

In some states a somewhat different doctrine prevails, and 
the court will presume that leaving the property with the seller 
amounts to a fraud, but the first buyer may rebut this pre¬ 
sumption, prove the sale bona fide, and recover the property. 
If, on the other hand, it can be shown in any case that the sale 
was not bona fide, but merely a sham, a creditor of the seller 
may treat the goods left with the seller as belonging to the 
latter and levy on them in settlement of his claim. 

A third party purchasing such goods with knowledge of 
the previous sale could not obtain a good title. Therefore, 
where for any reason possession of the goods is to be left with 
the seller for any great length of time, a formal bill of sale 
should be filed in the proper office of record. 

Conditional Sales 

It is entirely possible in the sale of goods for the seller 
to give the purchaser possession of the property constituting 
the subject matter of the sale but still retain the ownership of 
the property until the purchase price is paid. Such agreements 
are known as “conditional sales” (Form 4). 2 

The technical distinction between a conditional and an ab¬ 
solute sale is that the sale is absolute when the transfer of title 
is complete, whereas in a conditional sale the title is not trans¬ 
ferred but is to be transferred at some future time, upon the 
performance of a condition, namely, payment of the purchase 
price. 

In other words, in an ordinary conditional sale the pay¬ 
ment of the purchase price is by the express terms of the 
agreement a condition precedent to the transfer of title to the 
goods. Sales made on the instalment plan and providing that 


2 Because of the existing variations in the state laws on the subject of conditional sales 
different forms must be used to comply with the different requirements. 



68 


LEGAL NATURE OF SALES 


Conditional Sales Agreement 

This agreement certifies that Myrtle F. Bowles, the undersigned, now 
living at 2339 Kemper Lane, Cincinnati, Ohio, has received from the Stein- 
kamp Player Piano Company, a corporation under the laws of Ohio, one 
Model C player piano, returnable on demand, in good order and repair, and 
valued at one thousand dollars ($1,000). This the undersigned agrees to use 
with care and keep in good order and condition, and she agrees to pay for 
the use of it as follows: 

On delivery of said property, two hundred dollars ($200), which shall 
be accepted as payment for rent until January 1, 19—, and thereafter she 
shall pay at the rate of fifty dollars ($50) per month in advance on the first 
day of each and every month, without notice or demand, at the office of the 
said Steinkamp Player Piano Company, No. 642 West Twelfth Street, Cin¬ 
cinnati, Ohio. If default be made in any of the payments so provided, or in 
case the undersigned shall sell, offer to sell, remove, or attempt to remove 
said property from under her custody or control, without the consent in 
writing of the said Steinkamp Player Piano Company, then this lease shall 
cease and terminate, and the said Steinkamp Player Piano Company, or its 
agent, is hereby authorized to take actual possession of said property wher¬ 
ever the same may be. 

It is further agreed that the undersigned may at any time within said 
rental period purchase the said player piano by paying the named valuation 
therefor, and in that case the rent therefore paid shall be deducted from the 
purchase price. If any instalment of rent is not paid when due, or if said 
property is not returned upon demand, the undersigned agrees to pay an at¬ 
torney’s fee of twenty-five dollars ($25) in case her lease is placed in the 
hands of an attorney for collection of said rent, or to recover possession of 
the said player piano. 

Signed: 

Myrtle F. Bowles 

Cincinnati, Ohio 

November 9, 19—. 

Witnessed: 

Henry L. Woodward 

Form 4. Conditional Sales Agreement 

title shall pass to the purchaser upon payment of the last 
instalment, afford a very common but nevertheless typical 
illustration. 

Affidavits to Conditional Sales Contracts 

The opportunity afforded for the perpetration of fraud 
under such circumstances is obvious, and for this reason such 
sales have been made the subject of special legislation in most 
states, generally providing that for such sales agreements to 
be enforcible the seller must file certified copies of them in the 
proper office of public record. This serves as public notice, 
just as in the case of a realty mortgage. The importance of 


THE PASSING OF TITLE 


69 

this requisite becomes readily apparent when it is pointed out 
that in event the seller has not complied with it and the buyer 
has dishonestly disposed of the goods to some innocent third 

party, the seller is unable to recover the property. 

✓ 

Destruction of Property Pending Payment 

There is such a divergency of opinion in the court decisions 
on this point that no general rule or principle can be laid down. 
In some states the seller loses, and in others the buyer. When 
such destruction takes place the buyer usually discontinues his 
payments and the question arises as to whether or not he may 
be held liable for the unpaid balance. 

Example: A conditional sale was made of a soda fountain 
which was installed in the buyer’s place of business and was to 
be paid for in instalments. Before the final payment was made, 
the store was destroyed by fire. It was held that the risk of 
loss was in the buyer, although title was in the seller. 

Such a contingency as the loss or destruction of property 
constituting the subject matter of conditional sales is oftentimes 
anticipated and guarded against by means of property insur¬ 
ance, the cost of which is, of course, included in the sale price 
of the goods. 

Example : A conditional sale was made of a player piano, on 
which a part payment was made and a note given for the unpaid 
balance. On default at maturity of the note the seller re- 
plevined the piano without tendering back the amount of the 
part payment. It was held that the seller had title to the goods 
before default and upon default obtained the right to possession 
of the property also, without tendering back the amount paid, on 
the ground that it would be unjust to compel him to take back 
used property and also refund the amount paid on it. 

In a few states such forfeiture is done away with by 
legislation. Section 18 of the Uniform Conditional Sales Act 
provides for the redemption of the goods by the buyer within 
a limited period after the seller retakes possession. 


LEGAL NATURE OF SALES 


7 ° 


State Laws on Conditional Sales 


Whereas the state laws on the subject in most states are 
similar, they are by no means uniform. For instance, some 
states require an affidavit by the seller setting forth the terms 
of sale (Michigan, New Hampshire, Nebraska, Ohio, Penn¬ 
sylvania, and Wyoming). Others only require that the signa¬ 
ture of the seller to the contract be witnessed and attested by 
some responsible third party. Florida goes still further and 
requires also a personal acknowledgment on the part of the 
seller. 

In the following states it is only necessary to record a copy 
of the contract signed by the purchaser: 


Alabama 

Kansas 

Maine 

Maryland 

Minnesota 

Montana 


New York 
Oklahoma 
Texas 
Vermont 
West Virginia 


There are also states in which conditional sales are good 
against third parties without any such formality: 


Arkansas 

California 

Idaho 

Indiana 


Nevada 
Rhode Island 
Tennessee 
Utah 


Void and Voidable Title 

A legal distinction is made between what is termed a “void” 
and a “voidable” title which becomes of considerable import 
to a credit man in connection with the recovery of stolen prop¬ 
erty, and goods with which the seller has parted through fraud. 

A thief may have possession as the result of his theft, but 
he never acquires title to stolen property. He cannot, there¬ 
fore, pass a good title to the purchaser of the stolen property. 
Consequently, the rightful owner can always recover stolen 
property, even if found in the hands of an innocent purchaser 
for value. This is what is characterized as a “void” title. 


THE PASSING OF TITLE 


7 i 


Example: A, a thief, smashes the window of B’s jewelry store 
and steals a watch which he sells to C, an innocent purchaser 
for value. B can recover the watch from C. 

If, however, a seller is induced through fraud voluntarily 
to part with possession of and title to the goods, the perpetrator 
of the fraud acquires a “voidable” title, meaning one which is 
void so far as the fraudulent party is concerned, but one 
which becomes valid in the hands of an innocent purchaser for 
value, the underlying principle being that the party (seller) 
who has made commission of the fraud possible should bear 
the loss rather than an innocent third party. 

Example : A, by falsely representing himself to be the nephew 
of some prominent millionaire, obtains a watch from B on credit, 
which he later resells to C, an innocent purchaser for value. 

B, on discovering the fraud, wishes to recover the watch from C. 

He cannot. A’s voidable title became valid in the hands of C, 
an innocent purchaser of the goods for value. 


CHAPTER VI 


WARRANTIES 


Kinds of Warranties 

A question which often arises in the sale of merchandise 
is just how far a salesman or agent of the selling house may 
go in representing his goods to the buyer without subjecting 
his employer to liability for a breach of warranty. It is a mis¬ 
take to assume that the seller is not bound by any representa¬ 
tion unless the terms “warrant” or “warranty” are expressly 
used. In fact, there may be a breach of an “implied warranty” 
without any express misrepresentation whatever having been 
made. 

In other words, a warranty may be either express or 
implied. But in either case the warranty is a separate, inde¬ 
pendent, and collateral undertaking on the part of the seller 
for which the sale is the consideration. 

Express Warranties 

An express warranty is any promise or assurance made 
by the seller relating to the goods, if the natural tendency and 
actual result of such representation is to induce the buyer to 
purchase the goods. If the purchaser relies on his own judg¬ 
ment in selecting the goods, there is no warranty, even though 
the seller may have misrepresented them to such an extent as 
would otherwise constitute a breach of warranty. 

Example : A buys goods from B, who assures A that the goods 
may be used for a certain purpose. If it later develops that 
the goods may not be satisfactorily used for that particular 
purpose, there has been a breach of warranty. 

72 


WARRANTIES 


73 

Distinction between Statement of Fact and Expression of 

Opinion 

The seller must be careful to discriminate between a prom¬ 
ise, or statement of fact, and a mere expression of opinion. 
The latter is not binding on the seller and constitutes what 
is commonly referred to as “puffing one’s goods’’ or “sales 
talk.’’ For example, statements by the seller as to the value 
of the goods, or to the effect that the goods “are the best on 
the market’’ would be construed as such. 

The attitude of the courts, however, in construing such 
statements has been to hold the seller responsible for the 
language he uses and not to permit him to escape liability by 
claiming that he did not intend to convey the impression which 
his language was calculated to produce upon the mind of the 
buyer. That is, “the courts have in their later decisions mani¬ 
fested a strong disposition to construe liberally in favor of the 
buyer the language used by the seller in making any affirma¬ 
tion as to his goods, and have been disposed to treat such 
affirmations as warranties whenever the language would rea¬ 
sonably authorize the inference that the buyer so under¬ 
stood it.’’ 1 

Distinction between Express Warranty and a Condition 

There is a further important distinction, in legal effect, that 
is made between a condition, or promise which constitutes one 
of the terms or basis of the contract, and a warranty, which is, 
as previously stated, a collateral or subsidiary promise, in that 
a breach of the former entitles the party relying upon it to 
treat the contract as broken, whereas a breach of the latter 
gives rise merely to an action for damages. 

Implied Warranties 

The general rule in the law of sales is that of the old com¬ 
mon law doctrine of caveat emptor, meaning “let the buyer 


14 Met. 151, 155. 


LEGAL NATURE OF SALES 


74 

beware,” when trading in the open market. The exceptions to 
this rule constitute what are known as “implied warranties, 
wherein the seller assumes the risk instead of the buyer. 

An implied warranty may be defined as one which arises 
by operation of law and is not dependent for its existence upon 
any misrepresentation by the seller. In other words, there 
are certain implied warranties to which the seller is legally 
bound even though nothing was said about them at the time 
the sale was made. The following are the principal warranties 
that are implied in the sale of merchandise at common law: 

1. That the seller has a right to sell the goods; or if it be 

a contract of sale, that he will have the right to trans¬ 
fer title when the time for delivery arrives. 

2. That possession by the buyer shall not be disturbed by 

any claim made by others against the goods. 

3. That the goods shall be reasonably fit for the purpose 

for which they are ordinarily used. 

Example: B orders of C, a leather dealer, a new leather fan 
belt for his automobile. Owing to the inferior quality of the 
leather used, the belt breaks. C is liable to B for damages. 
There has been a breach of the implied warranty that the leather 
belting shall be sufficiently strong and reasonably fit for the 
purpose for which it was to be used. 

Sale of Goods by Description 

In the sale of goods by description the purchaser does not 
even see a sample of the goods, and so it is only logical that 
the seller should be held to higher principles of business con¬ 
duct than where the buyer actually sees the goods or a sample 
of them. This is at least the view reflected in section 14 of 
the Uniform Sales Act: 

Where there is a contract to sell or a sale of goods by descrip¬ 
tion, there is an implied warranty that the goods shall corre¬ 
spond with the description and if the contract or sale be by 
sample, as well as by description, it is not sufficient that the bulk 
of the goods corresponds with the sample if the goods do not 
also correspond with the description. 


WARRANTIES 


75 


Implied Warranties of Quality 

The provisions of the Sales Act restrict the liability of 
the seller of merchandise, as concerns implied warranties of 
quality, to a greater extent than was true at common law. 
Section 15 provides: 

Subject to the provisions of this act and of any statute in 
that behalf, there is no implied warranty or condition as to the 
quality or fitness for any particular purpose of goods supplied 
under a contract to sell or a sale, except as follows: 

(1) where the buyer, expressly or by implication, makes 

known to the seller the particular purpose for 
which the goods are required, and it appears that 
the buyer relies upon the seller’s skill or judgment, 
there is an implied warranty that the goods shall 
be reasonably fit for such purpose. 

(2) where the goods are bought by description from a 

% 

seller who deals in goods of that description, there 
is an implied warranty that the goods shall be of 
merchantable quality. 

(3) if the buyer has examined the goods, there is no im¬ 

plied warranty as regards defects which such exami¬ 
nation ought to have revealed. 

(4) in the case of a contract to sell or a sale of a specified 

article under its patent or trade name, there is no 
implied warranty as to its fitness for any particular 
purpose. 

(5) an implied warranty or condition as to quality or 

fitness for any particular purpose may be annexed 
by the usage of trade. 

(6) an express warranty or condition does not negative a 

warranty or condition implied under this act unless 
consistent therewith. 

Sales by Sample 

In the case of a contract to sell or a sale of goods by sam¬ 
ple, section 16 provides: 

(a) there is an implied warranty that the bulk shall cor¬ 

respond with the sample in quality. 

(b) there is an implied warranty that the buyer shall 


76 


LEGAL NATURE OF SALES 


have a reasonable opportunity of comparing the 
bulk with the samples. 

(c) if the seller is a dealer in goods of that kind, there is 
an implied warranty that the goods shall be free 
from any defect rendering them unmerchantable 
which would not be apparent on reasonable exami¬ 
nation of the sample. 

Warranty Not Available to Subpurchasers 

It is settled law that the mere resale of a warranted article 
does not give the subpurchaser a right to sue the original seller 
for damages caused by defects either in the title or quality of 
the goods. This principle of law is apparently based on the 
theory that a warranty, like an insurance policy, must be con¬ 
strued as a contract of personal indemnity. However, a buyer 
who has bought goods with a warranty may recover damages 
which he has been compelled to pay a subpurchaser to whom 
the goods were sold with a similar warranty. In this way the 
original warrantor is in effect made liable in the same amount 
that he would have been had the warranty been held to run 
with the goods. 

Oral Warranty Excluded by Written Contract 

Undoubtedly the existence of a separate oral agreement as 
to any matter on which a written contract is silent and which 
is not inconsistent with its terms, may be proven by parol, if 
under the circumstances it may properly be inferred that the 
parties did not intend the written paper to be a complete and 
final statement of the whole of the transaction between them. 

And when the contract itself upon its face is couched in such 
terms as import a complete legal obligation without any un¬ 
certainty as to the object or extent of the engagement, it is con¬ 
clusively presumed that the whole agreement of the parties 
was reduced to writing (Greenleaf on Evidence). 

If the sale or contract to sell be within the statute of frauds, 
and if a note or memorandum be relied on as evidence of com¬ 
pliance therewith, such note or memorandum must also contain 
the express warranty, if there is one. Otherwise, evidence of such 
warranty will not be received. If, however, acceptance and re- 


WARRANTIES 


77 


ceipt, or part payment, be relied on as evidence of compliance 
with the statute, oral evidence of an express warranty is then 
admissible. 2 

Implied Warranty Not Excluded by Written Contract 

The obligation attached to a contract for the sale of goods 
cannot be changed by the mere fact that the contract has been 
reduced to writing. The writing, it is true, is deemed to express 
the whole agreement of the parties, but since this particular 
liability arises from the nature of the transaction and the rela¬ 
tions of the parties, without express words, or even actual inten¬ 
tion, it remains a part of the seller’s obligation unless in some 
way expressly excluded. All implied warranties therefore at¬ 
tach to a written as well as an unwritten contract of sale. 3 

Remedies for Breach of Warranty 

In most states a buyer to whom title has passed cannot 
rescind a sale for breach of an express warranty, but has a 
right of action for damages resulting from the breach. In 
other states he may do either—rescind the sale, or keep the 
goods and sue for damages for the breach of warranty. 

For the breach of an implied warranty the buyer may at 
his election either: (i) rescind the sale and recover the price 
paid, or (2) accept the goods and sue for damages for the 
breach. 

If he elects the former right, he must notify the seller of 
his intention to do so promptly, or within a reasonable time 
and if the seller refuses to accept the goods when tendered 
back, the buyer may hold them as bailee for the seller until 
an adjudication has been made as to their respective rights. 


2 Irwins, Summary of Sales, p. 89. 

3 Ibid., p. 90. 



CHAPTER VII 


LAWS GOVERNING THE VALIDITY OF SALES 

CONTRACTS 

Transitory Causes of Action 

Suits on contracts constitute what are known as “transitory 
causes of action,” by which is meant that it is not necessary 
to bring suit on a contract within the state and county in which 
the contract was entered into, but that such actions may be 
brought and enforced in any state, provided proper service may 
be obtained upon the defendant within the state in which the 
action is brought. And when such an action is brought in 
a state other than that in which the contract was entered into, 
the plaintiff is not enforcing a foreign law, but rather a for¬ 
eign-acquired right, which is transitory and can therefore be 
enforced anywhere. 

Contracts to Sell 

Where a contract to sell merchandise is made in one state 
to be performed in another state, the general rule of law is 
that the validity of the contract is determined in accordance 
with the laws of the place of its creation, or the state in which 
it was entered into (the lex loci contractus ); whereas the ques¬ 
tion of performance of the contract is to be determined in 
accordance with the laws of the state in which it was to be 
performed. 

In this connection it may be noted that the Statute of 
Limitations affects the remedy and not the right of action, and 
it is, therefore, the statute of the state in which the action is 
brought rather than that of the state in which the contract was 
entered into which governs in such cases, as, for example, a 

78 


VALIDITY OF SALES CONTRACTS 


79 


contract to sell made in New York to be performed in Con¬ 
necticut. Assuming the Statute of Limitations on such causes 
of action is 5 years in New York and 10 years in Connecticut, 
the fact that the statute had run in New York where the con¬ 
tract was made would not affect or bar the prosecution of the 
cause of action in Connecticut. And if the Statute of Limita¬ 
tions on such cause of action was 20 years in Oklahoma, one 
would still have an additional 10 years in which to recover on 
his contract by bringing his suit in Oklahoma. 

Contracts of Sale 

When one is dealing with contracts of sale the law of the 
state in which the property is located determines the passing 
of title, and such contracts are therefore enforced in accord¬ 
ance with the laws of the state wherein the goods or merchan¬ 
dise are located. 

Uniform State Laws 

In the United States a unique legal system has been estab¬ 
lished in that certain powers of sovereignty are vested in the 
federal government, while others are reserved to the respec¬ 
tive states. Those reserved to the federal government are those 
set forth in the United States Constitution, which has been 
construed to exclude all legislative powers not thus reserved to 
the federal government. 

This, of course, is simply another way of saying that the 
various states are independent legal units and sovereignties 
unto themselves, except in so far as their legislative powers 
are restricted by the federal Constitution. And it is due to 
this fact, together with the additional fact that the conditions 
which the different state laws are enacted to govern, vary, that 
the laws of the various states are not more uniform. In other 
words, it is this multiplicity of jurisdictions that is primarily 
responsible for the great diversity in the decisions and statutes 
of the various states. 


8o 


LEGAL NATURE OF SALES 


In so far as conditions of a strictly local or state nature 
are concerned, no great practical inconvenience results from 
it, but the inconvenience, confusion, and impracticability re¬ 
sulting from this divergency of state legislation to a merchant 
doing a national or interstate business is obvious, as it means 
that his rights under precisely the same set of circumstances 
may be quite different in one state from what they are in an¬ 
other, depending entirely upon the state within which his cause 
of action has arisen. And it was with a view to overcoming 
the inconvenience and confusion resulting from this unneces¬ 
sary, but nevertheless existing, variance in the state laws con¬ 
cerning commercial trading, that a national Commission on 
Uniform State Laws was appointed in 1892. 

National Commission for Uniform State Legislation 

The primary object of the commission is not to change the 
laws of any particular state or states, but to codify the best 
features of all into one set of general rules or principles, and 
thus bring about a greater uniformity of state legislation on 
the subject under consideration for practical purposes, since 
this end is unattainable through the federal government be¬ 
cause of constitutional limitations. 

The manner in which this object is accomplished is by 
means of committees appointed by the American Bar Associa¬ 
tion to formulate a set of general rules or legal principles which 
shall govern and regulate the rights of the parties growing out 
of some particular phase of commercial trading. This set of 
rules, or code, is then submitted to the American Bar Associa¬ 
tion for approval, which in turn recommends it to the legisla¬ 
tures of the various states for enactment as one of their state 
statutes. Assuming their recommendation to be acted upon 
favorably by all the state legislatures, uniform legislation 
throughout the United States, in so far as that particular sub¬ 
ject is concerned, would thereby be obtained. 

A menace to the accomplishment of this purpose, however, 


VALIDITY OF SALES CONTRACTS 81 

lies in the wide divergence of the judicial interpretation of the 
provisions of the statute, due to the attempt on the part of the 
local courts to perpetuate former established principles. This 
tendency in some instances has been sufficiently prevalent to 
defeat the real purpose of uniform state legislation, and in an 
effort to overcome it a Committee on Uniformity of Judicial 
Decisions has been appointed to tabulate the decisions rendered 
under the commercial acts, and which is at all times made 
available to the courts. In this way it is hoped to bring about 
a uniformity of “judge-made law” as well as statute law, for 
it is realized that until this is accomplished there can be no 
actual uniformity. 

Whereas no open resistance has been manifested by the 
states against such uniform legislative measures, practical dif¬ 
ficulties which have been encountered and have had to be over¬ 
come, have rendered the task of securing the adoption of such 
acts difficult. However, the need for such uniformity in com¬ 
mercial legislation unquestionably exists and the modern legis¬ 
lative tendency is toward that end. As James Bryce in his 
“Studies on Jurisprudence” has said: “The more any depart¬ 
ment of law lies within the domain of economic interest, the 
more do the rules that belong to it become the same in all 
countries, for in the domain of economic interest Reason and 
Science have full play.” 

Uniform State Laws Enacted 

Thus there are two ways in which uniform legislation may 
be obtained throughout the United States: 

1. By federal enactment within the legislative powers of 

Congress, as the Bankruptcy Act. 

2. By state enactment of a uniform statute by the legis¬ 

latures of the various states, as the Negotiable In¬ 
struments Law. 

The Commission on Uniform State Laws held its first 
meeting in 1892, and since then has approved and recom- 


82 


LEGAL NATURE OF SALES 


mended for adoption some eighteen uniform acts, the two most 
important of which are the Negotiable Instruments Law, the 
oldest and most widely adopted of the uniform acts, drafted 
in 1896; and the Uniform Sales Act, drafted in 1906. The 
former has been enacted in all the states and territories except 
Georgia and Porto Rico, whereas the latter has been enacted 
in the following states: 


Arizona 

New Jersey 

Connecticut 

New York 

Idaho 

North Dakota 

Illinois 

Ohio 

Iowa 

Oregon 

Maryland 

Pennsylvania 

Massachusetts 

Rhode Island 

Michigan 

Tennessee 

Minnesota 

Utah 

Mississippi 

Wisconsin 

Nevada 

Wyoming 


Copies of both of these acts should be in every credit de¬ 
partment for reference purposes. Other such uniform acts 
which have been recommended and approved in this manner, 
are the Uniform Bills of Lading Act, Partnership Act, Con¬ 
ditional Sales Act, Warehouse Receipts Act, Stock Transfer 
Act, and the Workmen’s Compensation Act. 


PART III 


SAFEGUARDING PAYMENT IN THE SALE 

OF GOODS 



CHAPTER VIII 


ANALYSIS OF MERCANTILE CREDIT 
Risk in Credit-Granting 

Speaking generally, the merchant who discounts his bills 
or pays cash for his goods is using the profits from past busi¬ 
ness to trade on, whereas the man who buys on credit may be 
said to be trading on an anticipated profit of the future. Con¬ 
sequently, it becomes necessary for the merchant who sells on 
credit to forecast as accurately as possible, through the eyes 
of his credit department, the conditions which are to produce 
these profits. In other words, there is more or less risk in¬ 
volved in all credit transactions and it is the difficult task of 
the credit man to determine in just what degree that risk is 
present in any given case. 

To be able to do this requires special qualifications of both 
a personal and technical nature—qualifications which enable 
him to analyze and estimate correctly the mental, moral, and 
financial assets of an applicant in such a way as to establish his 
financial or credit responsibility. Yet, as has been previously 
said, there is no mystery connected with the duties of a credit 
man, and no secret formula need be used in the practice of 
what has been termed the “new profession.” 

In the first place we must understand just what a “line of 
credit” means or represents, as the situation with which the 
first half of our general subject is concerned, stated briefly, is 
this: A house wants to do business with your company—how 
are you to determine whether or not you will extend them a 
line of credit, and, if so, the credit limit that is to be placed 
on the account? 


85 


86 SAFEGUARDING PAYMENT IN SALE OF GOODS 


As we have already seen, the extension of mercantile credit 
actually amounts to a loan of capital in the form of merchan¬ 
dise on the part of the creditor. So in extending mercantile 
credit the real problem that presents itself is: How are you to 
determine whether or not you will loan a merchant or busi¬ 
ness firm a part of your capital in the form of goods? 

Confidence in Borrower 

To take first a personal illustration, assume that an indi¬ 
vidual has only $10 to loan, and three friends, A, B, and C, 
each of whom wishes to borrow it. With the choice of select¬ 
ing one of three, what factor or factors would naturally de¬ 
termine which one he would select in preference to the other 
two? Would it not be the likelihood or probability of repay¬ 
ment? In other words, he would not loan it to any one of the 
three friends if he did not think it would be repaid. If he did 
decide to loan it to one of them it would at least mean that he 
felt confident that the friend would repay him. Or, to put it 
in another way, before he would part with his $10 he would 
have to have confidence in the party to whom he was loaning it. 

If, then, there is no substantial difference between the case 
of his loaning $10 of his personal capital, or money, to a friend, 
and a business house loaning a part of its capital to a customer 
in the form of goods or merchandise, it therefore follows that 
just as he would first have to have confidence in the party to 
whom he was to loan his $10, a business house must first have 
confidence in the customer, or applicant for credit, to whom 
it is going to loan a part of its capital in the form of merchan¬ 
dise; that is, before it will extend him credit. 

Factors upon Which Confidence Depends 

The next question is: How is the lender to determine 
whether or not confidence may be reposed in an applicant for 
credit? To continue the analogy the question may be asked: 
What principal factor or factors would be taken into considera- 


ANALYSIS OF MERCANTILE CREDIT 


87 


tion in deciding whether or not he should loan $10 to A, B, or 
C? What kind of a fellow would the borrower have to be? 
What attributes or qualities would he have to possess ? 

If the lender is to prefer one over the other two, it is obvi¬ 
ous that some mental process of elimination must be carried 
out before such a selection can be made, and the incidental 
process or line of reasoning may be either crude or scientific. 
In fact, the only real difference that exists between the process 
of elimination that would be carried out by an individual in 
extending a personal loan and that of a credit man in extend¬ 
ing a line of credit is that, whereas it is likely to be of a rather 
crude and more or less subconscious nature in the former case, 
in the latter it will be a more scientific and conscious process, 
carried out by the credit man in accordance with well-defined 
rules and principles. But in both cases the object and purpose 
of going through such a process of elimination is the same, 
namely, solely to determine the apparent likelihood of the re¬ 
cipient of the loan fulfilling his promise to pay later. So the 
next step in our analysis of mercantile credit is to ascertain 
the factors upon which that likelihood naturally depends. 

To complete our analogy, let us further assume that: A 
was honest, but had no money and was not working; B was 
dishonest, but a man of limited means, temporarily out of 
funds; C was honest, had no money, but was working and 
earning a good salary. 

Now let us analyze and apply this information relating to 
A, B, and C, each of whom is equally desirous to borrow the 
$10. 

1. When we say A is “honest,” we mean that if he has $10 on 
the day he promised to pay you back, there is every reason to 
believe that he will willingly do so. 

“Good character” = Willingness to pay if he can 

2. B is dishonest, but has sources of future income, which 
means that he very likely will be able to repay as he promised, 
but, being dishonest, it is more or less doubtful as to whether 


88 SAFEGUARDING PAYMENT IN SALE OF GOODS 


he would be willing to pay if he thought he could successfully 
evade it. 

3. C is honest and is working, which means that he will not 
only be willing to repay you if he can, but that he will very 
likely be able to do so because he is earning a salary, or has the 
capacity to earn the money with which to repay you. 

The Credit Equation 

1. A, with good character alone, is not a good credit risk. 

One cannot pay one’s bills or finance a business merely with 
good intentions. 

2. B, with sufficient capital, but of questionable character, 
is not a good credit risk. To loan money to such a man would 
be almost equivalent to purchasing a lawsuit. 

3. C, with good character and earning capacity, would be a 
good credit risk. Such a man would not only be willing to repay 
the lender if he could, but also would possess the means of 
accomplishment necessary to fulfil his promise. 

If the extension of mercantile credit is substantially analo¬ 
gous to a personal loan of money, or capital, it must follow 
that the same three factors are to be taken into consideration 
by a business house in extending credit as by an individual 
in extending a loan. To express the same thought in other 
words, the degree of confidence that may be placed in an appli¬ 
cant for credit is measured by what are known and commonly 
referred to by credit men as the “three Cs of credit”— 
character, capital, and capacity. 

We can therefore state the “credit equation” in the fol¬ 
lowing form: 

Character + Capital -f- Capacity=Unlimited credit. 

Credit Factors Analyzed 

So in extending a concern a line of credit a lender expresses 
his confidence in its ability and willingness to meet whatever 
obligations it may incur up to a certain amount, known as its 
“credit limit,” which is based primarily on three elements, 
which are: 


ANALYSIS OF MERCANTILE CREDIT 


89 

1. The character of the interested parties, connoting their 

willingness to pay, as signified by their: 

(a) Moral principles. 

(b) Habits. 

(c) Antecedents. 

(d) Reputation. 

2. Their capital, or available resources with which to pay, 

as shown by the relation existing between their busi¬ 
ness assets and liabilities as set forth in a financial 

or property statement. 

3. Their capacity or ability to succeed, as manifested by: 

(a) A record of their business experience. 

(b) Skill manifested in overcoming business diffi¬ 

culties. 

(c) Mental, moral, and physical fitness for the busi¬ 

ness in which they are engaged. 

In other words, if we had but to ask for the information, 
we would want to know everything on which depends a con¬ 
cern’s business standing. In fact, the information which a 
credit department desires is literally unlimited—any fact con¬ 
nected with the individual’s past record, condition of his busi¬ 
ness, his personal habits, integrity, domestic life. Nothing is 
too trivial to be of interest as bearing on the case, and if such 
complete data were always available, the work of the credit 
man would be a joy. Unfortunately, however, the limited data 
oftentimes placed at his disposal makes it necessary for him 
to depend largely upon his personal experience and general 
knowledge of the business in estimating the risk involved. 

These three elements, then, constitute the working basis for 
credit-granting, and when one has satisfied himself as to the 
character of the men he is to deal with, their available resources 
and prospects for success, he is in a position to estimate the risk 
involved in extending them a line of credit. We shall therefore 
proceed to examine and discuss each element separately, and 
later consider their relation and relative importance in arriv¬ 
ing at a final decision. 


SAFEGUARDING PAYMENT IN SALE OF GOODS 


90 

1 . Character 

Several years ago the late J. P. Morgan was called to testify 
before a special committee of Congress charged with the in¬ 
vestigation of certain economic conditions existing at the time 1 
and in the course of the examination he was asked relative to 
a loan of a million dollars made to a certain party. “On what 
security was the money advanced, Mr. Morgan?” “No security 
whatever,” he replied, “for he had none to put up, but merely 
on the strength of his character.” 

This concrete example well serves to illustrate the practi¬ 
cal importance of this element in obtaining, or granting credit, 
for it can be safely assumed that a man of good character can 
be depended upon to pay his bills whenever possible. In other 
words, the moral risk counts for more than anything else, or, 
“Collateral can never take the place of character.” 

Just what is meant by “character” when referred to in 
connection with “credit”? We mean a man’s willingness and 
inclination to pay his bills, which in turn is significant of and 
based on the soundness of his moral principles, for personal 
actions and conduct undoubtedly serve as a reliable index to 
one’s character. 

Furthermore, a man’s character does not undergo any great 
change overnight, so that the investigation should always 
include a customer’s past business history, in order to ascertain 
if he has ever been associated with any questionable trans¬ 
actions. 

While experienced credit men differ in their estimate of the 
relative importance of this element of character, suffice it to 
say that even to the few who do not consider good character 
a sine qua non to the extension of credit—adverse information 
on this score is at least regarded as a danger signal, for capital 
and capacity count for little when a clever rascal starts out 
with the deliberate intention to “beat” his creditors. 


1 Pujo Money Trust Investigation. 



ANALYSIS OF MERCANTILE CREDIT 


91 


2 . Capital 

We have just observed how important it is, in extending 
credit, to consider first a credit-seeker’s willingness to pay. 
But were a business house to make a practice of accepting 
the will for the deed, it would soon find itself saying “Good 
morning to the district referee in bankruptcy. Hence the 
further necessity of considering the probability that he will be 
able to pay—his available means, or working capital. 

In other words, assuming a merchant to be of good char¬ 
acter and proved ability, there is still an element of risk in 
selling him goods on credit when the actual means of payment 
is lacking at the time the sale is made, and the granting of 
credit under such circumstances constitutes what is known in 
credit terminology as a “moral risk,” meaning the risk involved 
in extending credit to merchants whose only shortcoming is a 
lack of capital, on the assumption that an honest man would 
not incur a debt unless he could see his way clear to pay it 
when due. 

The amount of actual capital invested in the business means 
little to the credit man, as it may be so tied up in bad accounts 
or unsalable merchandise that he has not sufficient resources 
available to meet his current expenses. It is rather the manner 
in which a merchant handles his capital that has the most 
important bearing on his financial standing, for just as a good 
housekeeper can run a house on what a poor one wastes, a 
thrifty merchant with small capital can so manage his business 
and regulate his finances as to constitute a safer risk than one 
with a larger capital but less foresight. 

The property or financial statement showing the relation 
existing between the assets and liabilities of the business fur¬ 
nishes the most satisfactory source of information in this 
connection. The analysis of such statements with a view to 
determining the financial responsibility of the applicant will 
be discussed later (see Chapter X, “Preparation and Analysis 
of Financial Statements”). 


SAFEGUARDING PAYMENT IN SALE OF GOODS 


92 

3 . Capacity 

Just what is meant when we ask if a man has capacity or 
ability? We mean: Is he a good business man—has he the 
necessary equipment, mental and physical, to conduct his busi¬ 
ness successfully, including such factors as education, health, 
age, experience, and initiative? In other words, measured by 
his personal efforts, has he demonstrated his ability to assume 
successfully the responsibility incidental to the management of 
a business? 

There is certainly an element of truth in the saying, “A 
fool (though honest) and his money are soon parted,” which 
is simply another way of saying, that to make a success in 
business one must possess a certain amount of ability. The 
capacity may be “native,” in the sense of having been inherited 
from a superior parentage, or acquired by special training or 
business experience; but in either event the result is the same, 
in that it tends toward the development of what might be 
termed an intuition or aptitude for doing the right thing, in 
the right way, at the right time. 

Moreover, there is also undoubtedly a close relationship 
existing between capacity and what is generally meant by the 
very common, abstruse term “efficiency,” which partakes some¬ 
what of a cause-and-effect relation. Capacity connotes the 
force which sets the machinery in motion and guides it along 
a prescribed course, whereas efficiency is the result, or practical 
effect of the adjustment, for when we ask whether so and so 
or such and such an organization is efficient, what we generally 
mean is: Has the end in view, or the object sought, been accom¬ 
plished or attained with a minimum of time, effort, and 
expense ? 

What is the test of the presence of this element in ana¬ 
lyzing an application for credit? It may be said to be reflected 
in the extent to which modern business methods have been 
adopted in the management of the applicant’s affairs, and the 
skill he has demonstrated in overcoming business difficulties 


ANALYSIS OF MERCANTILE CREDIT 


93 


encountered—evidence of the fact that he knows his business— 
as contrasted with an unmethodical and slipshod manner of 
conducting the business, coupled with an unprogressiveness and 
lack of initiative, which manifest an inability to keep abreast 
of the times. 

As to the importance of the element of capacity, in the last 
analysis it simply amounts to this—other factors being equal, 
the healthy, forceful, broad-minded, and aggressive man is 
more likely to succeed than one who is sickly, dull mentally, 
narrow-minded, and easy-going. 

Relation and Relative Importance of the Credit Factors 

Together the three elements of character, capital, and capac¬ 
ity constitute the standard whereby every applicant for credit 
is measured in determining the risk involved in extending him 
credit, and when the credit man has analyzed the situation 
from these three points of view, he is in a position to decide 
whether his standing is such as to justify the company selling 
him on open terms. 

However, a merchant need not possess all three of these 
business assets to obtain a reasonable line of credit from even 
the most conservative houses; otherwise the volume of trading 
in the commercial world today would not amount to a third 
of what it is, for only a relatively small percentage of appli¬ 
cants are blessed with the possession of all three factors, 
whereas approximately 90 per cent of our commercial trans¬ 
actions are based on credit. 

But credit men do differ in estimating the relative impor¬ 
tance of the three elements, i.e., where one lays greatest stress 
on character, another may judge a risk solely by the customer’s 
financial responsibility, whereas a third may be guided prin¬ 
cipally by the ability he has manifested in the management and 
development of his business. Hence the classification of credit 
men as being either “materialists”—those who insist upon some 
tangible assets (capital) being present, or “idealists”—those 


94 


SAFEGUARDING PAYMENT IN SALE OF GOODS 


who lay greatest stress on the personal factors, character and 
capacity, which cannot be measured in dollars and cents. 

This division of opinion among credit men may be attrib¬ 
uted largely to a difference in the results of their actual expe¬ 
rience, for credit men are only human and it is but natural that 
they should be influenced greatly by the success or failure that 
has attended their risks and out of which their present policy 
has been developed. In other words, if one credit man has 
suffered his greatest losses through a reliance on capital alone, 
it would tend to increase his respect for the other two factors; 
whereas another whose company has found it most profitable 
to insist upon tangible assets on which to base a line of credit, 
would quite naturally consider capital the most important ele¬ 
ment. Thus actual experience is one way to determine the 
relative importance of the three factors. 

Another way to measure their relative importance is based 
on statistics compiled yearly by the mercantile agencies, show¬ 
ing the causes of business failures within the previous year. 
For instance, if the chart shows 12 per cent of the business 
failures were due to fraud, 20 per cent to lack of capital, and 
40 per cent to incompetency, it is helpful to a credit man to 
know that whereas one out of every ten failures was due to 
fraud, two were due to a lack of capital, and four to a lack 
of ability. 

Character Most Important Factor 

A man may have ability, he may be honest, he may have 
capital, and still fail; but the consensus of opinion of ex- 
perienced credit men seems to be that the element of risk in¬ 
volved is reduced to a minimum when both good character and 
capacity are present, and it is seldom that an applicant pos¬ 
sessing both is deprived of the benefit of a reasonable line of 
credit, for it would be strange indeed if such a man with the 
assistance of capital, in the nature of the credit extended him, 
did not succeed. In other words, theoretically at least, char- 


ANALYSIS OF MERCANTILE CREDIT 


95 


acter + capacity = the best combination, because once such a 
merchant is supplied with capital in the form of merchandise, 
he has all three elements of credit; whereas one possessing 
character and capital could not be supplied with business 
capacity. 

Furthermore, character, or integrity, may be regarded as 
the most important of the three factors, for given a man with 
ample resources with which to pay, and apparently capable but 
of questionable character, and you have a credit risk in every 
sense of the word. Or, as put by the late J. P. Morgan: “No 
matter how great may be the financial resources of a growing 
business, without character it cannot expect credit.” 

One writer in commenting on the relative importance of the 
three factors summarized his conclusions in this manner: 

A combination of small capital, good character, thrift and 
industry is a much better groundwork for a line of credit to a 
customer, than is large capital, indifferent character and habits, 
and loose unbusinesslike methods. It goes without saying that 
adequate capital, unimpeachable integrity, and strict business 
methods constitute the ideal risk. 

He might also have added that where favorable information 
on any one of these factors is lacking, time and experience alone 
will determine to what extent the account is desirable. 

Business Conditions 

To succeed as a credit executive a man should at all times 
keep in close touch with general business conditions. No 
period in our commercial history could better illustrate the 
necessity of this than the readjustment period of 1920-1921, 
because it clearly and conclusively demonstrates that business 
concerns which succeed well enough in ordinary times may be 
utterly unable to cope with competitive conditions under ad¬ 
verse business conditions, and it was the credit men who were 
able to foresee the change that has taken place in economic 
conditions who suffered the least. 


96 SAFEGUARDING PAYMENT IN SALE OF GOODS 

This simply means that whereas the points of inquiry in 
investigating a merchant’s credit responsibility remain the 
same at all times, the information that is obtained must be 
construed in the light of prevailing business conditions. 

Attitude of the Credit Man 

Finally, before leaving this subject, let us consider what 
should be the proper attitude of the credit man in extending 
credit to the trade, for on this largely depends not only the 
volume of business transacted but the popularity of the house 
as well. 

In the first place, it goes without saying that in these 
days of keen competition and business rivalry, a liberal policy 
in extending credit is absolutely essential to the healthy growth, 
expansion, and progress of a business; and by “liberal” is not 
meant a loose or reckless policy, but rather a prudent, open- 
handed policy, tempered with due discrimination and a proper 
regard for those conditions and circumstances which determine 
the degree of risk involved, bearing in mind all the while the 
ultimate object or purpose of the credit man—to sell all the 
goods he can with the least possible percentage of loss. 

Such a policy is made possible and at the same time 
profitable by the fact that most business men are honest, 
some inherently and others because they realize it is the best 
policy, leaving but a small percentage of dishonest merchants 
in business and consequently making it safe for credit men to 
proceed on the assumption that his customers will pay if they 
can, even though, as an abstract proposition, they have no 
definite moral conception of honesty or commercial integrity. 

It therefore follows that to carry out such a policy suc¬ 
cessfully, a credit man must have unlimited faith in humanity 
and the capacity to develop friendly and confidential relations 
with the trade, for the head of the credit department of a 
prosperous business concern is no place for a man that is 
narrow in his views, naturally incredulous, or parsimonious in 


ANALYSIS OF MERCANTILE CREDIT 


97 


his dealings, because a cramped credit policy is bound to show 
itself in a decline in the growth and progress of business. 

Summary 

The following may be stated, in summarizing the infor¬ 
mation developed in this chapter: 

1. Extending mercantile credit amounts to loaning a part 

of the business capital in the form of merchandise. 

2. Before a man or business house loans its money or capi¬ 

tal it must have confidence in the party that is to 

receive it. 

3. Confidence depends upon and is measured by the three 

C’s of credit—character, capital, and capacity. 

Or, expressed in a sort of perverted syllogism: 

1. Extension of mercantile credit depends on confidence 

in customers. 

2. This confidence depends upon the likelihood that they 

will pay as promised. 

3. Likelihood that they will pay as promised depends upon 

character, capital, and capacity. 

4. Therefore mercantile credit, in the last analysis, depends 

upon and is measured by: 

Character 

Capital 

Capacity 

When we have reached that stage in our investigation, the 
next problem that confronts us has to do with the manner and 
means whereby we are to find out or ascertain whether an ap¬ 
plicant for credit is of good character, and whether or not he 
has any capital or business capacity. And that brings us to 
our next subject, “Sources of Information.” 


CHAPTER IX 

SOURCES OF CREDIT INFORMATION 

Facts as an Aid to Judgment 

Credit men are no different from men engaged in other 
fields of business when it comes to arriving at decisions. 
Good judgment on any question consists in first securing all 
the relevant information about it one can, and then assigning 
the correct weight and importance to each fact. In other 
words, a credit man can have no confidence in a judgment 
based on insufficient or unreliable data. 

The first requisite, then, for making good decisions is a 
trustworthy method of ascertaining facts on which to base a 
decision. 

The Mercantile Agencies 

Now that we know the nature of the information we want, 
let us consider the various sources available, and means em¬ 
ployed, to obtain it. 

The standard agencies, the Bradstreet Company, and R. 
G. Dun and Company, undoubtedly constitute the most popu¬ 
lar source of credit information, and it is generally through 
either or both of these channels that the credit man starts his 
investigation, particularly for enlightenment as to the moral 
and mental make-up of the applicant. Then, if additional in¬ 
formation is desired concerning his finances, a property state¬ 
ment may be asked for. 

Both agencies publish quarterly a book of ratings con¬ 
taining the name and business address of every individual, 
firm, or corporation engaged in business (they supply infor¬ 
mation on mercantile companies only) in the United States 

98 


SOURCES OF CREDIT INFORMATION 


99 


and Canada, with two ratings—a capital rating and a credit 
rating—the former intended to show the financial strength of 
the concerns, and the latter the agency’s opinion as to the 
degree of confidence that may safely be reposed in them, based 
on their general policy of trading and particularly the manner 
in which they meet their bills. They are now each reporting 
on over two million firms in business. This data is checked 
over, revised, and republished four times a year, but a sub¬ 
scriber cannot hold the agencies responsible for losses resulting 
from reliance on their information because, theoretically, they 
are acting as his agents. Nor do they guarantee the veracity 
or accuracy of the information submitted in their reports. 

Organization of Agencies 

The general organization, or modus operandi, adopted by 
both agencies is quite similar, as each maintains a central office 
in New York and district managers in charge of the sectional 
offices established throughout the country, each of which is 
supposed to be self-supporting. 

Three kinds of investigators are employed: (i) traveling 
reporters, (2) local representatives, and (3) attorneys and 
other correspondents. Each is assigned so many accounts to 
investigate and “write up” after the information has been 
checked up through court records, state reports, insurance 
companies, etc., and inquiries made among the trade. It is 
on the facts gained from these sources and contained in the 
written reports that the ratings of the concerns are based. 

Ratings 

Both agencies aim to give substantially the same informa¬ 
tion, but each uses a different “key”—so familiar to credit 
men that it is seldom referred to—to indicate their ratings. 

The ratings are determined by officials of the company, not 
by the investigators, and, as has already been pointed out, 
consist of two parts—a capital rating and a credit rating. The 


0 

> 

> 


> > 


> > > 


loo SAFEGUARDING PAYMENT IN SALE OF GOODS 


Bradstreet 


Estimated Wealth 


Grades of Credit 


G. 


). AA 

A 

H. 

. 500,000 to $1 

,000,000 



J. 


500,000 



K. 


400,000 



L. 

. 250,000 to 

0 


A 

B 

M. 


250,000 



N. 

. 150,000 to 

200,000 



O. 

. 100,000 to 

150,000 



P. 

. 75,000 to 

100,000 

R 

c 

Q. 

. 50,000 to 

75,000 




R. 

. 35,000 to 

50.000j 



S. 


35,000 



T. 


20,000 


r. 

D 

U. 


10,000 



V. 


5,oo°l 

. D 

E 

W. 


3,oooJ 



X. 


2,000 

. D 

E 

Y. 


1,oool 


E 

F 

Z. 


500/ 





B 


C 


D 


E 

F 

F 


former is supposed to represent the true net worth of the 
business, whereas the latter represents the grade of credit to 
which the merchant is in the agency’s opinion entitled, with 
particular regard as to the manner in which he pays his bills. 

The two ratings are absolutely distinct and bear no rela¬ 
tion to one another; for example, any suspicion that might 
attach to a merchant’s character or manner of trading would 
not affect his capital rating to any extent whatsoever, but only 
his credit rating. 


Special Reports 

In addition to the ratings contained in the rating books, 
the detail information on which the ratings are based is also 








































SOURCES OF CREDIT INFORMATION 


IOI 


R. G. Dun & Co. 


Estimated Pecuniary 
Strength 

High 

General Credit 

Good Fair 

Lt’d 

AA. 

. .. Over $i ,ooo,ooo. .. .*. 

....Ai . 

. .. 1 .. 

• 1 l A-- 

..2. .. 

A+. . . . 

... $750,000 to $1 

,ooo,ooo. 

.. Ai 

1 

1 A 

2 

A. 

. .. 500, ooo to 

750.000. 

.. Ai 

1 

i l A 

2 

B +. . . . 


500,ooo. 

1 

1 Vi 

2 

2K 

B. 


300,ooo. 

1 

iH 

2 

2 A 

c+.... 


200 ,OOO. 

1 

1 l A 

2 

2 V 2 

C. 

75,ooo to 

125,000. 


2 

2 A 

3 

D-f. ... 

50,ooo to 

75,000. 

• • 

2 

zVz 

3 

D. 

35,ooo to 

50,ooo. 

• • lV 2 

2 

2V2 

3 

E. 

20,ooo to 

35,000. 

. . 2 

2^ 

3 

3 V 2 

F. 


20,ooo. 

• • 2^ 

3 

2 >A 

4 

G. 

5,ooo to 

10,000. 


3 

3V2 

4 

H. 

3,ooo to 

5,000. 


3 

2 >A 

4 

J. 

2,OOO to 

3,ooo. 


3 

3 'A 

4 

K. 

1,ooo to 

2,ooo. 


3 

3 A 

4 

L. 

500 to 

1,000. 



3 V 2 

4 

M. 

. . . Less than 

500. 



3 V 2 

4 


The lines which separate the different grades of credit indicate the rat¬ 
ings ordinarily required by credit insurance companies before they will 
indemnify the shipper against loss. 


available to subscribers in the form of special reports, sub¬ 
mitted on request and for a very nominal sum, except when 
the information is confidential, being then too detrimental to 
be spread broadcast. It is then necessary to call at the office 
for it. The sale of these special reports supplies one of the 
main sources of revenue for the agencies. 

Request for such reports must be made on special blanks 
supplied subscribers by the agency, and the information asked 
for is submitted with the understanding that it is to be used 
for strictly legitimate mercantile purposes and regarded as 
strictly confidential. The reason for this is twofold: (i) to 
prevent non-subscribers from participating in the benefits of 

















































102 SAFEGUARDING PAYMENT IN SALE OF GOODS 


the service, and (2) to guard against the use of the informa¬ 
tion for some ulterior or malicious purpose. 

The contents of these reports includes detailed information 
bearing on the character of the interested parties, as judged 
by their past history, life, habits, and reputation; on their 
ability as judged by their past business record and the present 
condition of their affairs; and on their capital, both inside 
and outside the business. The conclusion of the whole report 
consists of a general statement in which the agency presents its 
opinion or judgment as to the net worth of the business, the 
credit limit which should be placed on the account, and any 
other features bearing on the risk involved. 

Reports of failures, fires, foreclosures, assignments, and 
other important changes in the business are supplied to sub¬ 
scribers who have asked for special reports, voluntarily and 
without charge, for several years after the report has been re¬ 
quested. 

Both agencies also publish weekly trade reports giving a 
current summary of business conditions existing throughout 
the country, based upon the reports they receive from their 
investigators, the idea being in keeping with their policy to 
keep abreast of all progress incidental to the granting of mer¬ 
cantile credit. 

Criticisms 

While the service of these commercial agencies is well- 
nigh indispensable to the commercial world, there are ways in 
which the service could be improved and made more satisfac¬ 
tory to credit men. Some of the criticisms are manifestly un¬ 
just, but others are well taken and the defects will undoubtedly 
be remedied and corrected in time: 

1. The agencies have been asked to indicate which of their 
ratings are based on signed financial statements, for occasions 
arise when this additional information in itself mighty suffice 
in the opinion of the credit man to justify filing an otherwise 


SOURCES OF CREDIT INFORMATION 


103 


doubtful order, as there is no doubt that a man will be more 
cautious as to the truthfulness of what he puts down in black 
and white than as to what he passes on to some reporter by 
word of mouth as casual information. 

Their failure to comply with this request is difficult to 
explain, in view of the fact that the percentage of property 
statements contained in their special reports has been estimated 
to be between 60 and 70 per cent, and is increasing from year 
to year. 

2. The agencies are also frequently criticized because of 
misleading information and inaccuracies occurring in their 
reports, but the writer believes an investigation would develop 
that the percentage of error is surprisingly low rather than ex¬ 
ceptionally high, based on the number of concerns on which 
the agencies report. Of course the agencies are not infallible, 
nor can they ever attain absolute perfection in their reports or 
ratings so long as they have to depend upon human effort for 
their information. Then again, it must be remembered that 
they have no means to compel a business man to give them 
data about his business. In such instances it is necessary for 
them to depend on outside sources for their information, and 
with credit men holding orders pending receipt of their reports, 
they often do not have sufficient time to make as careful and 
thorough an investigation as they otherwise would. 

3. The fact that their reports contain no ledger informa¬ 
tion affords no justifiable ground for criticism, as it simply 
does not constitute a part of the service, and it is not intended 
for the credit man who must have actual ledger data before 
passing an order. Such information, while highly desirable 
and greatly in demand by credit men, must be obtained through 
other sources, and the agency should not be criticized for 
failure to do something entirely without the scope of its 
service. 

4. The factor concerning which it is most difficult to obtain 
satisfactory information from the reports of the agencies has 


104 safeguarding payment in sale of goods 


to do with the practice of trade abuses, because such prac¬ 
tices do not readily come to their attention. 

5. To just what extent and in just what manner the 
agencies would justify the lack of uniformity in their reports 
is problematical, but there is undoubtedly room for improve¬ 
ment in the manner in which their data is presented, that is, 
from the credit man’s point of view—a shortcoming as to 
form rather than substance, and one easily remedied. 

6. Finally, their special reports are criticized on the ground 
that they are not always up to date—the data is not fresh. 
A report is revised twice a year; but suppose a merchant in¬ 
ventories his stock but opce a year, say in June, submits these 
figures to the agency reporter when he calls the following 
December, and they are later submitted in a special report 
requested in May. The figures are then approximately a year 
old. 

Assuming the necessary data available, the ideal agency re¬ 
port purports to submit a complete and accurate record of the 
following: 

The merchant’s antecedents. 

His character. 

His habits. 

His business history. 

His signed property statement based on a recent inventory. 

Trade reports about him. 

His fire record. 

Ratings assigned to him. 

Taken by and large it is safe to say that the credit man re¬ 
ceives greater value in return for the money expended in 
agency service than he does from an equivalent amount ex¬ 
pended for any other source of credit information. The value 
of these agencies in credit-granting may be more clearly ap¬ 
preciated, perhaps, if credit men should endeavor to con¬ 
template the situation that would exist if this service were 


SOURCES OF CREDIT INFORMATION 


I0 5 

suddenly discontinued. What other source of credit informa¬ 
tion could be turned to as a satisfactory substitute? 

Legal Aspects of Agency Service 

The precise legal relation existing between the mercantile 
agency, subscriber, and merchant, and the rights of action 
growing out of the relation, has been the subject of con¬ 
siderable litigation in the past, but the difficulties presented 
have since been practically set at rest by more recent decisions 
developing the general doctrine that “a statement made to one 
person with the expectation that it will be communicated to, 
and acted upon by, another, is the same as if made directly to 
the latter.” 1 

Specific cases in point have held that “one who makes a 
false statement to a mercantile agency as to his financial status 
is equally liable to a subscriber to the agency to whom they 
report it, and who thereupon relies to his injury and to the 
same extent as they would be liable had the statements been 
made originally, directly to the party injured.” 2 

“If the statement made by the merchant to the agency is 
changed by the latter, the merchant is not liable.” 3 

In the case of the Cortland Manufacturing Company v. 
Platt 4 it was held that a merchant who had made a true state¬ 
ment to a commercial agency was not bound to give notice of 
any change in his circumstances short of actual or imminent 
insolvency. 

As for the liability of the agency in furnishing information 
to the subscriber, it has been held, that: 

One who undertakes to furnish information as to the credit of 
individuals or corporations is liable, in the absence of an express 
contract to the contrary, for the negligent performance of that 
contract. 5 


1 Iasigi v. Brown, 17 Howard 183; McKenzie v. Weineman, 116 Ala. 194; Bradley v. 
Bradley, 165 N. Y. 183. 

2 Fecheimer v. Baum, 37 Fed. Rep. 167; Lindauer v. Hay, 61 Iowa 663; Salisbury v. Bar¬ 
ton, 63 Kans. 552. 

3 Wachsmuth v. Martini, 154 Ill. 515. 

4 83 Mich. 419. 

6 People v. May, 147 N. Y. 487. 



106 SAFEGUARDING PAYMENT IN SALE OF GOODS 


and that: 

A contract between a commercial agency and its subscriber 
does not release the agency from gross negligence in falsely 
representing that it had investigated a prospective customer 
upon the subscriber’s request. 6 

In a Pennsylvania case, it was held that: 

Where a person about whom an erroneous statement was 
made by a mercantile agency, is insolvent, the subscriber who 
has sold him goods on the faith of the statement, need not sue 
such insolvent before bringing suit against the agency. 7 

The courts also seem to have drawn a distinction between 
credit information interchanged between merchants, and state¬ 
ments containing information of the same nature made by a 
commercial agency. In the first place the general rule has 
been established that: 

Words imputing to one engaged in business, where credit is 
essential, non-payment of debts, or actions tending to lessen its 
credit responsibility, are libelous per se. 8 

An apparent exception to this general doctrine is: 

Where one to whom an inquiry is addressed regarding an¬ 
other communicates bona-fide and without malice, to the in¬ 
quirer facts regarding the one inquired about, the communica¬ 
tion is “privileged”; and hence one is justified in giving in good 
faith his opinion of the integrity and standing of a “tradesman” 
in response to an inquiry concerning him. 9 

However, in an Idaho case it was held: 

The report of a mercantile agency to its patrons on the finan¬ 
cial standing of a business concern is not a privileged communi¬ 
cation. 10 

In another case it was held: 

A mercantile agency must answer for any libelous publica¬ 
tion concerning a person’s credit. 11 

8 Munro v. Bradstreet, 155 N. Y. Sup. 833. 

7 Crew v. Bradstreet Co., 134 Pa. 161. 

8 Stannard v. Wilcox, 118 Md. 151. 

9 Melcher v. Beeler, 48 Colo. 233. 

10 Pacific Pkg. Co. v. Bradstreet, 25 Idaho 696. 

11 Denney v. Northwestern Credit Assn., 55 Wash. 331. 



SOURCES OF CREDIT INFORMATION 


107 


As to the length of time these statements remain in effect, 
in Sharplin v. Gummy, 32 it was held that the plaintiff was 
not justified in relying on a statement made 2)4 years previous 
to a commercial agency, and in a later case, Treadwell v. 
State, 13 it was held that a statement made 60 days previously 
could not justifiably be relied on. While this would seem to 
be a rather extreme or hard case from a creditor’s point of 
view, with the marked development in the efficiency of agency 
service, and in view of the rapid change in business condi¬ 
tions, the tendency of the law in this connection seems to be 
to restrict the length of time during which such statements 
may be relied and acted upon by creditors with legal protection. 

Interchange Bureaus 

The mercantile agencies purpose to tell whether or not a 
man can pay, but how much more helpful it would be to know 
that he actually does pay. In other words, suppose A wishes 
to do business with us and it will require a credit line of 
$5,000 to carry the account. We ask for agency reports and 
they tell us that A is of good repute, has been in business four 
years, owns the building he occupies, and is apparently enjoy¬ 
ing a successful business. How much more helpful it would 
be to know that Jones and Company and Smith and Company, 
both equally conservative in extending credit, have been selling 
A as high as $5,000 worth of goods for some time past and 
payments have always been satisfactory. Of course, there is 
but one way in which this information could be obtained—by 
examination of A’s account on the ledgers of Jones and Com- 
. pany and Smith and Company, and it was the great demand 
for this accurate information that has given rise to the develop¬ 
ment of what are known as “credit interchange bureaus,” 
which serve as a medium through which ledger data is ex¬ 
changed among merchants. 


12 168 Pa. 199. 
18 99 Ga. 779. 



lo8 SAFEGUARDING PAYMENT IN SALE OF GOODS 


In this connection we shall discuss: (i) the theory on 
which the service is based, and (2) its value as a source of 
information to the credit man. 

Theory of Service. The service is based on a system 
of reciprocity and co-operation of merchants engaged in the 
same line of business for their mutual protection—a willing¬ 
ness to give as well as to receive accurate information as to 
the manner in which members of the trade handle their ac¬ 
counts. This is accomplished by subscription to the bureau 
for the service, which in turn is conditional upon the merchant 
submitting a list of all accounts carried on his ledgers. These 
accounts are listed by the bureau and a complete list of all 
accounts submitted by subscribers (revised from time to time) 
is furnished each member of the bureau, which merely conveys 
to them the information that the bureau is in a position to 
supply them with ledger data on any or all of these accounts. 
When a request for such information is received, the bureau 
refers to its file, ascertains which members are carrying the 
account, sends them a blank specifying the information that is 
desired, and upon its receipt, compiles a report, a copy of 
which is passed on to the inquirer. 

Value of Service. The advantages of this sort of service 
are numerous, but as we shall soon see, it also has its limita¬ 
tions. First, let us assume that there are 25 wholesale grocery 
houses in Kansas City, all of them subscribers to the same 
interchange bureau. Not a single retail grocer in the city 
could then purchase a bill of goods on credit from one of these 
houses without any one of the other 24 being able to find out 
the amount of his purchase and the manner in which he paid- 
his bill. He cannot find out which particular house made the 
sale, but the report will show the amount of the purchase, when 
it was made, and when paid for. In this way it can always 
be ascertained whether a man is prompt or slow in his pay¬ 
ments, the amount outstanding, whether he is shifting from 
one house to another to elude a settlement of his account, 


SOURCES OF CREDIT INFORMATION 


109 


whether he is overbuying or possibly stocking up preparatory 
to making an assignment. In other words, under the assumed 
conditions, the service would be ideal. 

Next, let us assume that but 5 of these 25 wholesalers sub¬ 
scribe for the service. Of what value is it to know that A’s 
account with none of the 5 is past due, or that his purchases 
for the past 60 days have not been very heavy? He may owe 
one of the other 20 houses $1,000 that is 6 months overdue, 
and have made unusually heavy purchases from still another 
within the past week. 

The point is simply this—the value of the service is de¬ 
pendent upon the extent to which it is participated in by the 
members engaged in that particular line of business, in the 
same territory, and as business expands and trading becomes 
more extensive this sort of service will necessarily become 
less satisfactory. Theoretically it is ideal, but practically it 
has its limitations. 

Salesmen’s Reports 

In discussing salesmen’s reports as a source of credit infor¬ 
mation, two questions should be considered: 

1. To what extent is one justified, as a matter of good 

business policy, in asking a salesman to serve as an 
agent or representative of the credit department? 

2. To what extent can the credit information submitted 

by salesmen be relied upon? 

Fancy yourself a salesman employed to sell goods with 
salary, and possibly a commission, dependent upon the amount 
of your sales—would you want to be bothered and hampered 
by having to investigate personally and report on the financial 
responsibility of your customers? The salesman must sell 
goods, and in most concerns he is not asked to do anything else. 

However, a salesman is undoubtedly in a position to render 
valuable assistance to the credit department by reporting his 
inferences from personal observation; but it must always be 


110 SAFEGUARDING PAYMENT IN SALE OF GOODS 

borne in mind that the principal duty of a salesman is to sell 
goods and that he is naturally loathe to offend or embarrass a 
customer, or in any way jeopardize a sale. In justice to him, 
he should not be asked to supply any information except that 
obtained from a personal observation of the place of business, 
his personal opinion of the customer, and such information 
as can be obtained in a casual way without arousing the cus¬ 
tomer’s suspicion or asking him direct questions. 

Prompted by selfish motives, the attitude prevalent among 
salesmen is: The credit department doesn’t help Lne to sell my 
goods; why should it call on me for assistance in handling the 
account? It is only to those who have been educated to the 
advantages of such co-operation, and to the fact that a sales¬ 
man should be a company representative rather than a mere 
order-taker, that the idea is not repugnant. 

As for the value of a salesman’s reports, it will depend, 
first, upon his ability to size up a situation and draw correct 
and reliable conclusions, and, second, upon the extent to which 
he does not permit himself to become biased by his desire “to 
sell another bill of goods.’’ In other words, you have to know 
first your salesman before you can accurately estimate the 
value of the information he submits concerning an applicant 
for credit. If he is known to be a keen observer and an un¬ 
selfish representative of the house, greater dependence can be 
placed on the information he reports than when the opposite 
is known to be true. 

Bank Reports 

Though freely consulted, banks do not constitute a very 
satisfactory source of credit information; nor is this surprising 
when it is remembered that this is not one of the purposes for 
which the bank was established, and that credit inquiries are, 
as a rule, handled purely as an accommodation, in routine 
manner, by a force of subordinate clerks. 

A bank’s first duty is of course to depositors, or bor- 


SOURCES OF CREDIT INFORMATION 


hi 


rowers, whose confidence must be respected, and in justice 
to itself it cannot be of very great assistance to a credit man, 
simply because of the possibility that confidential informa¬ 
tion may be abused by a creditor. 

Suppose, for example, the merchant or concern being 
investigated is one of the bank’s depositors and the bank also 
holds some of its paper. The value of the securities would 
necessarily be affected by a contraction of its credit, so it is 
hardly reasonable to expect an unfavorable report under such 
circumstances; whereas the information from another local 
bank not handling any of the merchant’s business and not 
having had occasion to make a searching investigation of his 
affairs, is of a very general and non-committal nature. In 
fact, the number of reports received consisting merely of the 
bank’s favorite and conventional expression, “We believe 
the man honest and good for his needs,’’ is surprisingly large. 

Nevertheless, a large banking acquaintance is an asset to a 
credit man, for banks can often help him, provided they are 
so disposed, when the information desired is obtainable 
through no other source. 

Attorney Reports 

The attractive feature of attorney reports to credit men 
is that the information submitted is supposedly based on per¬ 
sonal knowledge or personal investigation, but they are gen¬ 
erally of little value, because the attorney is not sufficiently well 
paid to spend the necessary time in getting the information. 
Many concerns make it a practice to ask for attorney reports 
only in towns of less than 15,000, where his profession would 
be more apt to bring him in contact with the business men of 
his locality and enable him to get the information desired by 
the credit man with but little time and effort. 

In the larger cities many law firms have found this source 
of business sufficiently profitable to justify the installation of a 
special commercial department to collect and disseminate credit 


112 SAFEGUARDING PAYMENT IN SALE OF GOODS 

data, and by virtue of sufficient handling they soon succeed in 
amassing a wealth of information of greater value to the credit 
man than the service of the mercantile agency in that par¬ 
ticular locality. 

Credit Man’s Personal Judgment 

It is not to be understood that all of these sources of in¬ 
formation are employed in the investigation of every account. 
That is not only unnecessary, but is also entirely too expensive. 
In fact, it is only the doubtful accounts that require such a 
searching investigation, although the credit man likes to know 
as much as he can about all his accounts, and for this reason 
reports are frequently asked for even when the concern’s credit 
responsibility is unquestioned. In fact a credit man who con¬ 
ducts a well-regulated credit department will not be satisfied 
with merely drawing from one or two sources of informa¬ 
tion, but will “tap every spring from whence he has reason 
to believe there may flow such information as will be of use 
to him in deciding the merits of an account.” In other words, 
a complete and accurate file should be the aim of every 
conscientious credit man. 

All reports received through these various channels have at 
least one thing in common—they present another’s view of the 
situation. But to sense the actual conditions of a business, the 
evidence of retrogression or development, requires more than 
second-hand information. Consequently, such reports must 
be supplemented by the personal judgment of the credit man, 
based on his experience and knowledge of human nature, and 
on inferences to be drawn from the resources of the locality 
in which the customer is located—its population, classes of 
people represented, and the competition with which the mer¬ 
chant will have to contend. To illustrate, if a crop failure 
seems imminent in Kansas, it is but natural that he should want 
to restrict his credit lines in that section and handle his accounts 
accordingly; on the other hand, if a well-founded Qil boom is 




SOURCES OF CREDIT INFORMATION 


113 

under way throughout Oklahoma, he can afford, and is quite 
justified in assuming greater risks in this section, in view of 
the increased capital pouring into the state. 

A celebrated Frenchman once declared that genius was 
nothing more than the capacity for taking infinite pains. This 
certainly is true as applied to the development of genius or 
efficiency in connection with credit work. And it is simply 
another way of expressing the thought involved in the truism 
that ‘‘constant vigilance on the part of the credit man is the 
price of safety.” 


CHAPTER X 


PREPARATION AND ANALYSIS OF FINANCIAL 

STATEMENTS 

Accuracy of Information 

In investigating a merchant’s character and his business 
capacity, reliance must necessarily be placed largely upon hear¬ 
say reports and the opinions of others, because there is no 
concrete way of measuring a man’s honesty or ability. But 
in the investigation of a merchant’s financial strength, or the 
capital factor, this element of his credit responsibility can be 
figured out with mathematical precision. 

Order of Discussion 

When considering subjects of a strictly technical nature, 
the readiness and ease with which the fundamental principles 
are grasped and comprehended by the reader depend in large 
measure upon the sequence in which the different aspects of 
the subject are presented and discussed. And with this fact 
in mind special care and effort have been taken in this and the 
next several chapters to deal with the subject of financial 
statements in a way which will prove most helpful and easy of 
comprehension. 

The following outline will be observed: 

1. The preparation of financial statements. 

2. The theory of the analysis of financial statements. 

3. Application of the theory to simple statements, cor¬ 

porate statements—balance sheets and profit and loss 
statements—and comparative statements. 

• 4. Importance of working capital in a business. 


ANALYSIS OF FINANCIAL STATEMENTS 


i*5 

Form of Statement 

A financial, or property, statement is nothing more than a 
report or statement of the financial condition of a business or 
commercial organization at a given time, by setting forth in 
some classified manner the assets and liabilities. When sub¬ 
mitted as a basis of credit it should also conclude with a signed 
statement to the effect that: 

The above statement made ior the purpose of establishing 
credit is a full and correct statement of our financial affairs as 

of the.day of., 19—. 

Signed: 


The statement may be general or detailed in the manner 
in which the information is presented. It may be condensed 
or consolidated. But irrespective of these differences as to its 
compilation, it remains a financial statement. The information 
is there, whether the assets and liabilities are presented side by 
side, or one group above the other. And the information 
contained should be the same no matter by which name the 
statement is known—property statement, balance sheet, or 
financial statement. The difference is essentially a technical 
one, depending on whether the information is presented in the 
account or the report form. 

Parties Interested 

One general principle that can be laid down as governing 
the compilation of financial statements is that each statement 
must be complete as to content and arranged comprehensively 
if it is to be of any practical value or use. By this is meant 
that whatever plan of grouping is followed, the order on the 
liability side of the balance sheet should correspond with the 
order on the asset side; i.e., current liabilities should appear 
opposite current assets, and the fixed liabilities opposite the 
fixed assets. 

In considering this point it may be well, first, to look for a 





n6 SAFEGUARDING PAYMENT IN SALE OF GOODS 


moment at the parties in interest in such statements. These 
are, first, those who contribute the capital, or finance the organ¬ 
ization, second, those who manage the organization, and third, 
those who develop relations with the organization as debtors 
and creditors. Each of these is interested in knowing that his 
funds have been not only advantageously employed but that 
they are secure, and financial statements offer the means of 
satisfying the desire for such information. 

To the manager of the business, financial statements furnish 
him with excellent facilities for getting in touch with the gen¬ 
eral divisions of his organization which size and other condi¬ 
tions prevent him from coming in personal contact with and 
which thus transcend the limits of his personal observation. 

The creditors are equally interested parties. Before mer¬ 
chants or banks will extend credit or make loans, they insist 
on knowing that the concern seeking the accommodation is in 
good financial standing and what its prospective earning power 
is. Both these facts may be disclosed by properly prepared 
financial statements. In other words, financial statements 
which convey the proper information to the administrative 
officers or proprietor of a business are very likely to prove 
entirely satisfactory to any other party or parties at interest. 

Arrangement of Items 

A classified balance sheet appears to meet the requirements 
of all interested parties. By “classified” balance sheet is meant 
one in which the assets and liabilities are classified in accord¬ 
ance with their function in the business. Thus assets may be 
classified as capital assets, current assets, fixed assets, miscel¬ 
laneous, and deferred. In classifying liabilities very much the 
same order may be followed. Such a classification would give 
to any interested party information concerning the assets and 
liabilities. It would also enable anyone to compare any group 
of liabilities with any corresponding group of assets. Of 
course, in the case of a sole proprietorship or the ordinary 


ANALYSIS OF FINANCIAL STATEMENTS 


ii 7 

partnership, such statements will, as a rule, partake of a more 
simple form than those of an extensive corporate enterprise. 

As to the general arrangement, quite a difference of opinion 
and a wealth of discussion may be found. There are those 
who contend that the current assets should be shown first, 
arranged in the order in which they will be realized upon; and 
that the current liabilities should appear at the head of the 
statement on the other side, arranged in the order in which 
they will be liquidated. Others contend that capital assets and 
liabilities respectively should head the statement. Fundamen¬ 
tally the basis for this difference of opinion seems to be that 
those who argue for preference for the current assets and 
liabilities seem to have principally in mind the interest of cred¬ 
itors; whereas those who contend that the capital assets and 
liabilities should be given preference seem to look at the situa¬ 
tion from the standpoint of the proprietor or stockholder. 

In either case, however, the current assets should be ar¬ 
ranged in the order in which they will ordinarily be realized 
upon, namely, cash, accounts receivable, notes receivable, and 
merchandise. In the case of a going concern, goods not sold 
for cash are sold on account; and when a customer finds him¬ 
self unable to pay the account within the time stipulated in the 
terms of sale, he as a rule asks for an extension of time and 
tenders his note. 

The same principle of arrangement may be said to apply 
to the current liabilities. They should be listed according to 
the natural sequence in which they will be liquidated—owing 
for merchandise, accounts payable, notes payable, and the other 
current liabilities following in proper sequence. 

Whether investments, or securities owned, shall be classed 
as fixed or current assets is a debatable point and largely 
depends upon the purpose for which they are held. For exam¬ 
ple, it is not probable that anyone would think of considering 
shares of stock of a subsidiary concern held for purposes of 
control as a current asset. On the other hand, scarcely any- 


Il8 SAFEGUARDING PAYMENT IN SALE OF GOODS 


thing is more marketable or more readily and easily convertible 
into cash than certain classes of securities, e.g., Liberty bonds. 
Consequently, a proper test as to whether such investments or 
securities shall be classified as fixed or current assets would 
seem to be this: If such securities are held for purposes of 
control or as a permanent investment of excess capital until the 
time when the usual current assets will not be realized upon 
fast enough, they should be considered fixed assets; whereas 
if they are readily convertible into cash and are being held 
for the purpose of liquidating existing current liabilities, they 
should be considered as current assets. 

The items of good-will, copyrights, patents, etc., frequently 
come up for discussion, and the question of whether they 
should be included among the capital assets will be discussed 
later (see page 152). 


Statement Form Illustrated 

The general arrangement of the financial or property state¬ 
ment of a sole proprietor or a partnership is as follows: 


Assets 

Cash: 

On Hand. $ 

In Bank. 

Accounts Receivable. 

Notes Receivable. 

Merchandise. 

Fixtures . 

Realty. 


Liabilities 

Accounts Payable. $ 

Notes Payable. 

Owing for Merchandise.... 
Mortgages: 

Chattel. 

Real. 

Net Worth. 


Total.$. Total.. 

Form 5. Balance Sheet of a Sole Proprietorship or a Partnership 


Such a statement should also be supplemented with certain 
essential operating facts, the most important of which is the 
volume of sales, in order that the inventoried condition of the 
merchant may be ascertained. For some reason or other it is 
often quite difficult to secure such information and the objec- 

































ANALYSIS OF FINANCIAL STATEMENTS 


11 9 

tion is frequently raised that it is of too confidential a nature 
to risk the chance of it becoming known to a competitor. Dis¬ 
closure should also be made as to the presence of any contingent 
liabilities, such as hypothecated receivables, accommodation 
indorsements, etc. 

Forms of Financial Statements 

Almost all of the larger houses have their own special form 
of property statement, drawn up in accordance with their own 
ideas, and while they differ in form and arrangement, they are 
in effect the same, being compiled with a view to obtaining the 
same information in regard to a credit-seeker’s business affairs. 
The standard form (Form 6) drafted and adopted by the 
National Credit Men’s Association for an individual or part¬ 
nership will serve as a splendid example. 

The Theory of Statement Analysis 

It is an oft-quoted axiom that “figures don’t lie,” but for 
our purpose it might be well to add, “but credit men know 
better,” and a day’s experience at a credit desk suffices to 
justify and to corroborate this somewhat contradictory modi¬ 
fication. 

Financial statements when complete and carefully prepared, 
and when skilfully analyzed, supply one of the most satisfac¬ 
tory sources of information on which to base an extension 
of credit. Information and facts can be obtained which are 
not available to the credit man from any other source. And 
while the data are different in both arrangement and amounts 
in each and every statement submitted, the process of analysis 
remains the same and is applicable to all alike. Therefore, 
once the theory is understood, all that remains is to be able 
to apply it, which is largely a matter of training and experience. 
As for the importance of this ability, a remark frequently 
quoted is significant: “Here is where the credit man earns his 
salary.” 


120 SAFEGUARDING PAYMENT IN SALE OF GOODS 


“Large assets are not al¬ 
ways necessary to the crea¬ 
tion of credit; what is most 
desirable is, that credit be in 
relative proportion to the ac¬ 
tual assets.” 


PROPERTY STATEMENT 

TO 


“The giver of credit is a 
contributor of capital, and be¬ 
comes, in a certain sense, a 
partner of the debtor, and, as 
such, has a natural right to 
complete information of the 
debtor’s condition at all 
times.” 


Form Adopted and Recommended by the National Association of Credit Men 

For the purpose of obtaining merchandise from you on credit, we (I) make the following statement in 
writing, intending that you should rely thereon respecting our (my) financial condition as of (Date) 


(All questions should be answered. When no figures are inserted, write word “None.”) 


ASSETS 

Cash in hand. 



LIABILITIES 

For MERCHANDISE: 

Accounts owing not due. 



Cash in bank. 



Accounts owing by customers, good 
and collectible, not pledged or sold. . 



Accounts owing past due.... 



Trade Acceptances payable. . . . 



Notes owing by customers, good and 
collectible, not pledged or sold. 



Notes payable for Mdse. 



For BORROWED MONEY: 

Notes payable to banks. 



Trade Acceptances receivable, not 
pledged or sold. 



Notes or debts payable to others 
(including relatives and friends).. 



Merchandise: (not on consignment or 
conditional sale.) (How valued; 
Cost. Market.). 



Deposits of money with us. (De¬ 
scribe) . 



Other quick assets 

(Describe). 



Owing for Wages and Salaries. 



Owing for Taxes (city, state and fed¬ 
eral) 















Owing for Insurance Premiums. 



TOTAL QUICK ASSETS 





TOTAL QUICK LIABILITIES 







Depreciated....).. 



Debt secured by mortgage on land or 
buildings 



Fixtures and other Equipment. (How 
valued; Cost.... Depreciated ....). 



Debt secured by chattel mortgage or 
other liens 



Land and Buildings as described below. 









Other liabilities: 

(Describe). 



Notes and Accounts owing from offi¬ 
cers, employees, or others not cus¬ 
tomers . 






Other assets: 

(Describe). 












TOTAL LIABILITIES 
NET WORTH. 





TOTAL ASSETS 




TOTAL 








What books of account do you keep?. 

^ a3thiS ^f tement made fr ° m those books? Do you keep cost records?'. 

or pledge your accounts to creditors, banks, finance companies or others?. If so, 

. , , , . * s J 30 so ^ or pledged? $ . What amount of your accounts have you sold or 

pledged dunng the past twelve months? $ . 

Are any creditors secured by mortgage or lien of any sort?. If S o, how? 


Do you sell 

what amount 


Are any claims in attorneys’ hands or suits against you?. 

Have you merchandise on consignment or conditional sale?.If so," what amount? 

If business property is leased, for what term and what rental?. 

Name and locality of your bank or banks. 

Location and kind of business. 

Previous business experience. Where 


you will be able to make a year hence. py statement for comparison with the showing 


Form 6. Standard Form of Balance Sheet Adopted by the National 


























































































ANALYSIS OF FINANCIAL STATEMENTS 


121 


INSURANCE 

On Merchandise $ . On Buildings $ . Machinery $ . Fixtures $ 

Other Equipment $... Employers’ liability $ . 

Is any insurance assigned?. What amount?. To whom?. 

Amount of life insurance for benefit of business $ . 

With what companies. 


SUMMARY OF PROFIT AND LOSS 


Inventory of Mdse, beginning of fiscal 
year (not including fixtures or equip¬ 
ment) . 



Sales last fiscal year. 



Income from all other sources. . 



Inventory of Mdse, at close of year 



Cost of Mdse, purchased during the year. 
General expenses including salaries, 
losses, etc. 



Total Income for year. 


-— 

Less Total Expenses. 



TOTAL EXPENSES. . . . 



NET PROFIT FOR YEAR 


— 








RECORD OF LAND AND BUILDINGS 


Title in name of 

Description 
and location 

Book 

value 

Assessed 

value 

Amount of 
Encumbrances 

To whom 
































BUY PRINCIPALLY FROM THE FOLLOWING CONCERNS 


Names 

Addresses 

Amount Owing 

Open Account 

Notes 













V 

























Names and Addresses of Owners of Business 


REMARKS: 

The foregoing statement has been carefully read (both printed and written matter) and is in all respectg 
complete, accurate and truthful. It discloses to you the true state of our (my) financial condition on the 
date above stated. Since that time there has been no material unfavorable change in our (my) financial 
condition; and if any such change takes place we (I) will give you notice. Until such notice is given, you 
are to regard this as a con tinu-ng statement. 

Firm Name. 

Signed by. 

Street.T own.State. 

Date of signing statement.19.... 

Form R. 


Credit Men’s Association for Sole Proprietorship or Partnership 


















































































122 SAFEGUARDING PAYMENT IN SALE OF GOODS 

Comparison of Assets and Liabilities 

To begin with, we must know just what information we 
wish to obtain from a property statement. We want to deter¬ 
mine the true financial condition of the business. This we do 
by ascertaining the existing relation between the assets and 
liabilities, that is, by making a comparison between what it 
owns with what it owes—by striking its “credit balance,” so to 
speak. 

Assuming the total assets to be larger than the total liabili¬ 
ties, the difference represents what is known as the “net worth” 
or capital of the business—the proprietorship. A seemingly 
natural and logical inference is that the larger the net worth, 
the larger the line of credit to which the business is entitled. 
But this is “jumping at conclusions,” and it does not neces¬ 
sarily follow, as we shall soon see. 

From a credit point of view solely, a concern is in a healthy 
financial condition only when it has on hand or subject to 
immediate command at least sufficient cash to pay its debts as 
they fall due. So, a credit man is interested in finding out: 

1. The prospect of the buyer being able to pay the credit 

man’s bills as they fall due. 

2 . The likelihood of forcing a settlement of the account 

in event it becomes necessary. 

Classes of Assets and Liabilities 

A word of explanation is necessary at this point. It has 
to do with the distinction that is made between the quick, or 
current, assets, and the fixed assets; and also with the corre¬ 
sponding distinction between the quick, or current, liabilities 
and the fixed liabilities. In other words, we have two distinct 
kinds of assets and two distinct kinds of liabilities to deal with. 

The assets that are being converted into cash from day to 
day and which in turn are used and depended upon to pay the 
current expenses of the business are termed “quick,” or current 
assets. Such are the merchandise, accounts and notes receiv- 


ANALYSIS OF FINANCIAL STATEMENTS 


123 


able, cash, etc. 1 he other assets, although they represent actual 
value and money permanently invested in the business, cannot 
be used in payment of the current expenses incidental to oper¬ 
ating the business, and are therefore termed “fixed” assets. 
Such are the fixtures, furniture, machinery, tools, other plant 
equipment, and real estate. 

An analogous distinction is also made in the liabilities 
between what constitutes the quick or current liabilities and 
what constitutes the fixed liabilities—the former consisting of 
those obligations which will mature or fall due in the imme¬ 
diate future, such as bills owing for merchandise, and accounts 
and notes payable, and the latter consisting of the obligations 
which do not mature for some considerable time and are sub¬ 
ject to delayed payment, such as real and chattel mortgages. 

Prospect of a Buyer Paying His Debts When Due 

Speaking generally, whether a merchant will be able to 
pay his debts as they fall due will depend upon the amount of 
money he has on hand after paying his existing current obli¬ 
gations. How is the creditor to ascertain how much that will 
amount to ? By ascertaining the difference between the amount 
of money to be received from the current assets and the amount 
which is to be paid out in settlement of the current obligations. 
The excess of the former over the latter (when such exists) 
is called the “working capital” of the business. In other words, 
the difference between the current assets and the current lia¬ 
bilities constitutes the fund the merchant will have with which 
to pay your account. 

This is simply another way of saying that by “credit capac¬ 
ity” of the business we mean the power to discharge obligations 
as they fall due. This power depends not upon the amount 
of the capital in the business, but rather upon the form in 
which it is distributed among the assets. To express the same 
thought in still another way, it is the availability of the assets 
that measures the credit capacity of the business. 


124 SAFEGUARDING PAYMENT IN SALE OF GOODS 

So long as there are current or quick assets present in excess 
of current or quick liabilities, creditors have no immediate 
cause for anxiety. But reverse the situation and there is danger 
ahead, for under such circumstances it is obvious that creditors 
will have to wait for their money because the merchant can no 
longer pay his bills as they fall due. 

It is therefore clear that the prospects of a business pay¬ 
ing its bills promptly at maturity depends primarily upon the 
amount of its working capital. 

Determining the Line of Credit 

Assuming the amount of working capital available in the 
business has been ascertained, the next question that presents 
itself is: In what amount shall credit be extended? 

1. For the full amount? Let us suppose that the working 
capital of a business amounts to $5,000, and you extend credit 
for that amount; also that five other concerns which are selling 
it merchandise do likewise. Then, in event of a forced liqui¬ 
dation, how much would you and the other five creditors 
receive on your accounts? 

2. If not for the full amount, in what proportion? As a 
general rule, it should be gauged and measured by the relative 
proportion that your goods will bear to the entire business. 
If the working capital is $30,000, inasmuch as your goods will 
constitute one-fifth of the entire stock of merchandise, the 
credit line extended by you should be $6,000. 

This is simply an arbitrary rule, which is theoretically well 
founded but not strictly observed or adhered to in practice. 
If it were, it would serve to guard against and in large measure 
prevent overstocking, which is the usual forerunner of insol¬ 
vency. 

There are several reasons why this principle is not strictly 
observed and applied in practice: (1) The human element is 
ever present, and it is a natural characteristic of human nature 
“to take a chance” in some degree; and (2) it is oftentimes 


ANALYSIS OF FINANCIAL STATEMENTS 


125 

quite difficult even to approximate the ratio that your goods 
will constitute to the entire stock of the merchant, although 
the accuracy with which this can be done by a credit man of 
long experience in a particular line of business is surprising. 

Likelihood of Forcing Payment 

In calculating the prospects for collecting the full amount 
of the account in event it becomes necessary to force a settle¬ 
ment by means of legal process, the fixed assets and fixed 
liabilities must also be taken into consideration, because as a 
last resort the fixed assets may be subjected to sale, and after 
the liens or obligations outstanding against them, such as 
chattel mortgages, etc., have been satisfied, the proceeds may 
be applied in payment of the account. In other words, the 
second object of the credit man in analyzing a financial state¬ 
ment is accomplished by ascertaining whether there is a suffi- 
cent equity in the fixed assets to serve as a satisfactory and 
adequate protection, or insurance, against suffering an ultimate 
loss on the account. For this purpose the net worth or excess 
of total assets over total liabilities is not infrequently used. 

A situation is frequently encountered where the statement 
shows an appreciable net worth, but on analysis, no working 
capital; or, where the total assets are considerably in excess 
of the total liabilities, but where the quick liabilities are in 
excess of the quick assets. This situation represents what is 
meant by a “floating debt.” To extend credit to a concern in 
such a condition is almost equivalent to buying a lawsuit (the 
expense of which is not included in your selling price) inas¬ 
much as it is obvious from the finances of the business that the 
current obligations cannot be met as they fall due. 

Statement Analysis Illustrated 

Before proceeding further let us examine two simple state¬ 
ments by applying the process we have just been considering. 
The first statement is as follows: 


126 SAFEGUARDING PAYMENT IN SALE OF GOODS 


Campass and Company 

Wholesale and Retail Grocers 


Assets 


Liabilities 


Cash: 


Owing for Merchandise. 

$ 9,500.00 

In Bank. 


Accounts Payable. 

1,500.00 

On Hand. 

900.00 

Notes Payable. 

6,000.00 

Accounts Receivable... 

8,000.00 

Mortgage on Fixtures... 

3,000.00 

Notes Receivable. 


Mortgage on Realty. 

10,000.00 

Merchandise. 


Ne* Worth. 

26,500.00 

Liberty Bonds. 




Fixtures. 




Realty. 





$56,500.00 


$56,500.00 


Let us assume that you or your company is engaged in the 
manufacture of lard compound, which constitutes only one of 
the ten different products carried by the average wholesale and 
retail grocer. Classifying and separating the quick assets and 
quick liabilities in order to ascertain the working capital, we 
find the following: 


Quick Assets 


Quick Liabilities 

Cash in Bank. 

$ 2,000.00 

Owing for Merchandise. $ 9,500.00 

Cash on Hand. 

900.00 

Accounts Payable. 1,500.00 

Accounts Receivable. 

8,000.00 

Notes Payable. 6,000.00 

Notes Receivable. 

2,100.00 


Merchandise. 

17,000.00 

$17,000.00 

Liberty Bonds. 

1,500.00 



$31,500.00 

A working capital of $14,500 is thus disclosed. The fixed 
assets and fixed liabilities are as follows: 

Fixed Assets Fixed Liabilities 

Fixtures.$10,000.00 Mortgage on Fixtures... $ 3,000.00 

Realty. 15,000.00 Mortgage on Realty. 10,000.00 


$25,000.00 $13,000.00 

This discloses an equity in fixed assets of $12,000. 

Proceeding on the assumption that your company’s goods 































ANALYSIS OF FINANCIAL STATEMENTS 


127 


will constitute approximately one-tenth of the firm’s entire 
stock of merchandise, theoretically its financial status would 
justify his extending credit up to $1,450, or a credit line of 
$ 1 , 500 - 

The second illustrative statement is as follows: 


M. Deyer and Company 
Manufacturers of Misses and Children’s Dresses 


Assets 


Liabilities 


Cash in Bank. 


Accounts Payable. 

. $15,044.06 

Cash on Hand. 

125.19 

Notes Payable. 

8,100.00 

Accounts Receivable. 


Mortgage on Realty.... 

5,000.00 

Merchandise. 


Net Worth. 

. 40,000.00 

Furniture, Fixtures 

and 



Machinery. 




Realty. 





$68,144.06 


$68,144.06 


We will assume that your company is engaged in the manu¬ 
facture of dress trimmings, and that the average cost of the 
trimmings on a $25 dress amounts to $5, or 20 per cent of the 
cost of the materials used. 

Classifying and segregating the quick and fixed assets, and 
likewise the quick and fixed liabilities, we find: 


Quick Assets 


Cash in Bank. $ 1,018.87 

Cash on Hand. 125.19 

Accounts Receivable. 12,000.00 

Merchandise. 10,000.00 


$23,144.06 

Fixed Assets 
Furniture, Fixtures and 

Machinery.$30,000.00 

Realty. 15,000.00 


Quick Liabilities 


Accounts Payable. $15,044.06 

Notes Payable. 8,100.00 


$23,144.06 

Fixed Liabilities 

Mortgage on Realty. $5,000.00 


$45,000.00 



























128 SAFEGUARDING PAYMENT IN SALE OF GOODS 


In this case the analysis discloses that while there is a net 
worth of some $40,000 in the business, there is absolutely no 
working capital available. This signifies that after the existing 
current indebtedness is paid, no available current assets remain 
with which to satisfy your account in event credit was ex¬ 
tended, and hence the company constitutes an undesirable 
present risk in every sense of the word. 

Other Theories 

There was a time when it was the policy of banks to insist 
upon an existing ratio of 2 to 1 between the quick assets and 
the quick liabilities as the accepted measure of financial sound¬ 
ness, before they would extend credit to a merchant. But it 
is more or less doubtful if that rule was ever strictly applied. 
In any event it is not strictly adhered to in their present-day 
practice. This rule has, however, been accepted and is still 
applied in practice by many credit analysts. 

Owing to the diversity of opinion that exists on the sub¬ 
ject, it is interesting to note the views of several credit men 
of standing, and also a summary of the report made by the 
president of a large commercial bank after conducting a similar 
investigation. One well-known credit man commits himself 
to this extent: 

I usually look for a 2 : 1 ratio in analyzing a financial state¬ 
ment. However, I am willing to grant a line of credit even 
if this ratio is 1 : 1, providing the merchant has proven business 
ability and is morally O.K. 

In contrast, this opinion is expressed by another: 

I do not believe that there is any fixed ratio that is helpful 
in measuring credit. Credit is not, and never can be, measured 
by a carpenter’s rule. 

Following is a summary of the bank president’s view: 

Common practice has (as far as has been made public) de¬ 
veloped only one general theory of extending commercial credit 
which has become accepted as more or less standard. This 


ANALYSIS OF FINANCIAL STATEMENTS 


129 


theory is known as the two-for-one rule, and consists of the 
principle that in order to establish a good credit proportion, 
the statement must show at least two dollars of current assets for 
every dollar of current liability. The reason for this measure 
is basically sound, because from a credit standpoint companies 
must be looked at, partially at least, as a liquidating proposition, 
in which there is bound to be a shrinkage of assets, in that some 
accounts will be slow and bad, and some merchandise out of 
season and antiquated, whereas the corresponding debt is not 
subject to shrinkage. These proportions have become accepted 
only by common practice, and there is a question as to whether 
the two-for-one, or the 200% ratio, is right, too large, or too 
little. It provides a substantial margin, and has on that ac¬ 
count become rather generally acknowledged as safe. The estab¬ 
lishment of any such ratio is not a matter of theory, but has been 
a matter of experimentation. The adoption of the current ratio 
theory is in itself purely a quantitative proposition, in which the 
current assets in bulk are measured against the current liabilities 
in bulk. It is quite as important, however, that a qualitative 
analysis of the current assets be made, and for that reason other 
ratios have been developed. . 

In discussing this subject Mr. Koelsch, former president 
of the National Association of Credit Men, has said: 

The ratio of 2 or 3 to 1 was a rough sort of working ruie in 
the period from 1897-1916 when prices did not vary enough or 
so quickly as to cause much trouble. The proportion of the 
assets to the current liabilities depends for its importance upon 
the character of the assets, and it does not pay a proprietor to 
deceive himself upon this point even if he can make the pro¬ 
portion satisfactory to creditors. 

This current ratio of 2 to I simply means that a debtor 
should have $2 of current assets for every $1 of current liabili¬ 
ties. This margin of current assets has always been demanded 
because of the moral certainty that the current assets will not, 
in liquidation, produce a full 100 cents on the dollar as entered 
upon the statement. The shrinkage in the value of the current 
assets, however, is not accompanied by an offsetting shrinkage 
in liabilities. 


130 SAFEGUARDING PAYMENT IN SALE OF GOODS 

“Acid Test” 

Still another way of testing the strength of a financial risk 
consists in applying what is commonly known as “the acid 
test,” whereby the total of the cash and the accounts and notes 
receivable (the merchandise and other current asset items are 
disregarded) is measured against, and is supposed to equal in 
amount, the total of the current liabilities. 

This test is even more conservative than the 2 to i standard, 
and there are, of course, many risks that should be considered 
good in spite of their inability to satisfy any such requirement. 


CHAPTER XI 


DESCRIPTION AND VALUATION OF ASSETS AND 

LIABILITIES 

Listed and Actual Valuations 

In actual practice there is still another phase of statement 
analysis to be considered which has to do with the determina- 
tion of the actual as distinguished from the listed valuation 
of the assets, for it can be safely assumed that the applicant 
for credit, in an endeavor to make a good showing, has listed 
his assets at their highest value and estimated his liabilities 
as conservatively as possible, rendering it obviously imprudent 
to accept the figures at their face value. It is thus necessary 
for the credit man to “shade the assets,” or to write off a 
certain percentage merely as a precautionary measure. The 
important factor is not the applicant’s opinion as to the value 
of his assets, which the listed valuation altogether too fre¬ 
quently represents, but the actual value that will ultimately be 
realized from them. The liabilities, as a rule, present no such 
difficulty, for what a merchant owes is a question of fact, e.g., 
if he owes you $200, his opinion as to whether it is more 
or less than $200 will not change the fact that the actual 
amount owing is $200. 

No fixed rule or principle can be laid down as governing 
this phase of the procedure, and the percentage that should be 
written off in estimating the working capital and the true net 
worth will vary in accordance with the different lines of busi¬ 
ness and the individual judgment of the credit man, as based 
upon his personal experience in the business. 

As a condition precedent, however, to the determination of 
the extent to which the various asset items should be written 


132 


SAFEGUARDING PAYMENT IN SALE OF GOODS 


off, it is necessary for the credit man to understand the nature 
of the assets he is dealing with—their susceptibility to inflation. 

Merchandise 

This item includes raw materials, goods in process of pro¬ 
duction, and finished goods which are to be sold in the ordinary 
course of trade. In appraising the worth of this asset con¬ 
sideration must first be given to the method employed by the 
maker of the statement in taking inventory, for various 
methods may be employed in valuing the merchandise. Was 
the inventory taken at cost, the prevailing market price, or the 
sale price? The more conservative practice is to use the lowest 
of the three, and this basis is considered preferable on the 
theory that the value of an asset, or its debt-paying power, is 
determined entirely by the amount of money that will be re¬ 
ceived for it at the time of its disposal, and that even though 
the cost of the goods be greater than the current market price, 
it is the prevailing market price which will determine their 
ultimate worth. 

Allowance must also be made for old stock and deprecia¬ 
tion, for it must be remembered that while in the ordinary 
course of business, merchandise is sold at a profit, the stock 
is subject to physical deterioration, changes in style and fash¬ 
ions, errors in buying, or decline in value. Furthermore, time, 
effort, and expense are required to convert it into cash, which 
necessitates an additional allowance for a percentage of the 
overhead expense. The larger the proportion of the merchan¬ 
dise in the shape of raw material, the greater is the prospect 
of realizing full value on the goods in the case of a forced 
sale, because as such it is not subject to changes in style, and 
is more readily convertible into cash. 

There is no uniform basis or scale for writing off the mer¬ 
chandise item. The percentage varies according to the value 
of the commodity represented within general limitations, and 
for several lines of goods is as follows: 


VALUATION OF ASSETS AND LIABILITIES 


133 


General Merchandise. 20%- 30% 

Groceries. 10 - 20 

Dry Goods. 20 - 25 

Hardware. 25 - 30 

Millinery. 35 - 60 

Clothing. 25 - 35 


Accounts Receivable 

Accounts receivable are simply book accounts, sometimes 
called “open” accounts, with the customers of the concern. 
Next to cash, accounts receivable represent the most live asset 
in the business of a merchant or manufacturer. The item 
should include only unpaid charges against solvent debtors 
which are reasonably certain to be paid at maturity, or within 
a reasonable time thereafter. That is to say, accounts receiv¬ 
able should include only those open accounts for goods sold 
and delivered which can be relied upon for the payment of 
creditors’ claims. 

Frequently, however, in an endeavor to bolster up this 
item, bookkeeping balances and even loss accounts which are 
not to be collected in the usual course of business and which 
have no debt-paying power whatsoever, are included, and it is 
to provide for this ever-present contingency that allowance 
must be made in estimating the worth of this item. 

Assuming, however, that only balances due from solvent 
customers are included, a normal allowance must still be made 
for bad debts, the percentage of which varies in different lines 
of business anywhere from 1 to 10 per cent. Where no dis¬ 
tinction is made in listing the accounts receivable between 
accounts good and collectible, and accounts overdue, the extent 
to which they should be written off varies from 25 to 50 per 
cent. 

Notes Receivable 

This item should include only negotiable promissory notes 
received from customers in payment for goods sold and de- 








134 SAFEGUARDING PAYMENT IN SALE OF GOODS 

livered. It should not include notes, or IOU’s from mem¬ 
bers of the firm, officers, directors, subsidiary or allied com¬ 
panies, or any other similar obligations. Nor should notes 
which have been discounted, assigned, or transferred be 
included. 

In most lines of business, debts for goods sold and de¬ 
livered are usually evidenced only by open book accounts, and 
where this system prevails the closing of an account by note 
indicates, as a rule, a past-due account on which an extension 
has been granted. In some lines of business, however, it is 
customary for concerns to close their open book accounts with 
trade acceptances, and where this system prevails the notes 
receivable should be valued in the same way as the accounts 
receivable in other industries. In fact, a higher valuation 
might be placed on the trade acceptances, for they should prove 
easier to collect than the open accounts receivable. 

Cash 

This item should represent the amount of cash on hand 
and in bank subject to immediate withdrawal. It should be 
remembered that in event the merchant is indebted to the 
bank in which his funds are deposited, the bank has a lien 
against the deposit for the amount of the loan. 

If free from encumbrance and correctly stated, the cash 
item may be accepted at its face value in estimating its debt¬ 
paying power. It is always advisable, however, to have the 
cash on hand and the cash in bank set forth as separate items, 
and in event the cash on hand is unusually large in amount, 
the inference may reasonably be drawn that it probably in¬ 
cludes some IOU’s or unexpended salesmen’s balances. 

Investments 

The credit man is often called upon to appraise the worth 
of various forms of outside investments, such as stocks or 
bonds of subsidiary companies, or securities in other com- 


VALUATION OF ASSETS AND LIABILITIES 


135 


panies. If the securities are readily salable, such as Liberty 
bonds or stocks listed on the New York Stock Exchange, 
they are quick assets and their value for debt-paying purposes 
is readily ascertainable. On the other hand, if the securities 
are stocks or bonds of subsidiary companies and held merely 
for purposes of control, they are fixed assets and not available 
for paying debts incurred in the ordinary course of business. 
If the item represents securities in other and unknown com¬ 
panies, they are, as a rule, disregarded entirely by the credit 
man in estimating the merchant’s credit capacity. 

Deferred Assets 

This item includes charges which have been paid in ad¬ 
vance and which are properly applicable to a subsequent period, 
such as taxes and unexpired insurance premiums. Beyond 
signifying that the merchant employs a comprehensive system 
of accounting, such assets, not having any debt-paying power, 
should be practically disregarded in analyzing financial state¬ 
ments. 

Plant, Machinery, and Tools 

In estimating the worth of such properties a sufficient al¬ 
lowance must be made to cover depreciation due to wear and 
tear, and obsolescence due to competition of other improved 
machinery and equipment. This is generally offset by a spe¬ 
cial reserve created for the purpose and carried as a lia¬ 
bility. 

Such fixed assets are not to be sold in the usual course of 
business and consequently are not available to meet current 
business obligations. On the other hand, their presence does 
add to the stability of a business, and in event of a forced 
liquidation they could be sold and the proceeds applied in pay¬ 
ment of creditors’ claims, although the amount realized would 
probably not amount to more than 50 per cent of their listed 
value. 


136 SAFEGUARDING PAYMENT IN SALE OF GOODS 


Furniture and Fixtures 

As in the case of the other fixed assets, adequate allow¬ 
ance should be made for depreciation, and in estimating the 
worth of this item in event of a forced liquidation, their 
listed value should also be written off approximately 50 per 
cent. 

Intangible Assets 

Intangible assets, such as patterns, good-will, unissued 
stock, copyrights, patents, and assets of like character, should 
be practically disregarded in analyzing financial statements. 
To a going concern they are not resources available for debt¬ 
paying, and to an insolvent concern they are Usually worth¬ 
less. 

Insurance 

The question of fire insurance is a very important one in 
considering a credit risk and a credit man should always re¬ 
quire information as to the amount of fire insurance carried, 
because in event no fire insurance is carried by the applicant 
for credit, a fire may destroy his entire stock and leave little 
for the payment of creditors. In other words, the merchant 
who does not carry adequate fire insurance is a dangerous 
risk. In event the amount of insurance carried is considerably 
less than the estimated value of the tangible assets, it justifiably 
leads to suspicion that the value of the assets has been over¬ 
stated. 

Life insurance on the lives of officers of a corporation, or 
the members of a firm, or the life of a sole proprietor, is 
frequently carried as a business investment and also as a 
further protection to creditors from some possible disaster 
which might seriously embarrass or possibly bankrupt a well- 
established business. In such cases the carrying of business 
life insurance tends to strengthen the credit risk by decreasing 
the potential risk of ultimate loss. 


VALUATION OF ASSETS AND LIABILITIES 


137 


Liabilities—Owing for Merchandise 

Turning now to the liabilities, the item, “owing for mer¬ 
chandise,” should always be shown as a separate and distinct 
liability. It should also be subdivided so as to show : (1) the 
amount not due, and (2) the amount past due. The reason for 
this is that the amount is not very apt to be understated when 
separately shown, for it is easily verified by creditors, espe¬ 
cially in the case of the insolvency of the debtor, whereas if 
the amount owing for merchandise was included with other 
business obligations under the one item of accounts payable, 
the item would be more susceptible to falsification and the 
detection of overstocking, the usual forerunner of bankruptcy, 
would be more difficult. 

Accounts Payable 

This should represent the total amount owing to creditors 
on open account, excluding, of course, the amount owed for 
merchandise when the latter is shown as a separate liability. A 
division of this item also should be made to show: (1) the 
amount not due, and (2) the amount past due. 

Notes Payable 

This item may include notes payable: (1) to banks, (2) 
to merchandise creditors, or (3) to others, meaning members 
of the firm, officers of the corporation, or relatives or friends 
of the individual merchant. 

If the amount owed to banks is large, it may represent 
loans negotiated for the purpose of discounting bills of pur¬ 
chase—an entirely legitimate and common practice. If the 
statement shows a large amount of notes payable to mer¬ 
chandise creditors, it as a rule represents trade acceptances out¬ 
standing which were given for supplies purchased. In such a 
case the “owing for merchandise” item should show a cor¬ 
respondingly low balance. The presence in the financial state¬ 
ment of a large amount of “notes payable to others” is usually 


138 safeguarding payment in sale of goods 

regarded as a signal for the exercise of caution on the part of 
the credit man, because when a merchant finds it necessary 
to borrow from his friends and relatives, it indicates that 
his banking credit has probably been exhausted. Furthermore, 
in event of insolvency it would be but a natural tendency for a 
merchant to place the interests of his friends and relatives 
above those of his general creditors. 

Reserves 

These usually represent the estimated depreciation of one 
or more of the assets, some accrued liability, or part of the 
surplus set aside for some particular purpose. In the latter 
case the title by which the reserve is designated would usually 
indicate its purpose. 

Mortgages 

The due date of a mortgage is of great importance to a 
credit man because it frequently happens that where property 
has greatly depreciated in value the mortgage may not be re¬ 
newed and thus an apparent asset represented by the book 
equity of the investment may be entirely wiped out by fore¬ 
closure proceedings, or possibly converted into a liability in 
event the property is sold for less than the amount of the 
mortgage. 

Practical Application of Analysis Theory 

Once the merchant’s working capital has been established 
with assets properly “shaded,” credit is extended accordingly, 
provided there is. a sufficient equity in the fixed assets to serve 
as a protection against any ultimate loss. We may examine 
several simple statements in the light of the preceding dis¬ 
cussion. 

The following statement, we will assume, is submitted by 
a wholesale grocery concern that is seeking from us a line of 
credit of from $ 2,500 to $ 3 , 000 : 


VALUATION OF ASSETS AND LIABILITIES 


139 


Assets 

Merchandise on Hand. $46,641.00 

Accounts Receivable. 5,250.00 

Cash on Hand and in Bank. 1,410.00 

Furniture and Fixtures. 4,800.00 

Store. 8,450.00 


Total Assets. $66,551.00 

Liabilities 

Owing for Merchandise. $9,500.00 

Loans from Bank. 2,400.00 


Total Liabilities. 11,900.00 


Net Worth. $54,651.00 


Assuming it customary to “shade” the merchandise of 
wholesale grocers one-fourth and the receivables from one- 
half to three-fourths of their estimated value, the wholesaler’s 
working capital amounts to approximately $25,803, found by 
subtracting from merchandise of $34,981, receivables of 
$1,312, and cash (as stated) of $1,410, the liabilities (as 
stated) of $11,900. 

This case then presents no great difficulties, for assuming 
our goods will constitute one-tenth of his entire stock, a credit 
line of 10 per cent of $25,803, or approximately $2,500, would 
be justified, particularly in view of the fact that fixed assets 
are present in sufficient amount to afford the necessary pro¬ 
tection. 

The following statement is submitted by another wholesale 
grocery house, and it will require a line of credit of $100 to 
carry the account: 

Assets 


Merchandise.$2,700.00 

Accounts Receivable. 3,000.00 

Cash on Hand and in Bank. 810.00 

Furniture and Fixtures. 500.00 

Equity in Residence. 1,000.00 


Total Assets. $8,010.00 






















1 4 o SAFEGUARDING PAYMENT IN SALE OF GOODS 

Liabilities 


For Merchandise, Not Due. $2,300.00 

For Merchandise, Past Due. 700.00 

Notes Payable. 500.00 

Total Liabilities. 3,500.00 

Net Worth. $4,510.00 


By writing off the merchandise and receivables in the same 
manner as before, we find his available working capital amounts 
to merchandise of $2,025, receivables of $750, and cash of 
$810, amounting in all to $3,585, less the quick liabilities of 
$3,500, or to $85. The fixed assets are valued at $1,500. 

Here is a case typical of the kind credit men often have to 
pass on, and upon which some are willing to take a chance. 
A large share of the merchant’s capital is represented by book 
accounts, showing that he either extends credit too freely or 
has included a large number of past-due accounts in his state¬ 
ment—just what portion of his outstandings are considered 
good and collectible, we are not informed. 

His merchandise indebtedness is larger than his stock on 
hand, from which it is quite evident that he is overtrading; 
and while it is not impossible, or, for that matter, improbable, 
that he may continue indefinitely in this uncertain and unstable 
condition, he is in no shape to “weather a storm,” and the 
element of uncertainty is too great to justify assumption of the 
risk. In other words, we are better off with the account off 
our books than we would be with our goods on his shelf. 

Collateral or Derivative Information 

These examples illustrate the simple and almost mechanical 
phases of statement analysis, whereas, in doubtful cases espe¬ 
cially, the credit man should continue his investigation by 
making such other comparisons as afford an insight into the 
manner in which the business is being conducted. A number 
of these are as follows: 









VALUATION OF ASSETS AND LIABILITIES 


141 

1. Business profits are directly dependent upon two factors: 
(a) the margin of profit realized on sales; (b) the number 
of times that profit is made, which is the business turnover. 
In other words, by “turnover” we mean the number of times 
a year a merchant is able to convert his stock of merchandise 
into cash. The ability to “turn” merchandise into cash quickly 
indicates good management; for, assuming the margin of profit 
to be the same, the merchant who can turn his stock over, 
say four times a year, realizes more on his capital investment 
than a competitor who is able to turn his stock but three times. 

Given the merchandise on hand and the annual sales, we 
can calculate the approximate number of times a merchant is 
turning over his stock by dividing the merchandise on hand 
into the annual sales, as shown below: 


Annual sales ($30,000) 
Merchandise on hand ($5,000) 


=Annual turnover (6 times) 


While this is the usual method adopted by credit men in 
figuring the approximate turnover, it is neither correct nor 
accurate from a strictly technical standpoint, due to the fact 
that the turnover has been figured on the volume of sales, 
which includes profits, whereas the merchandise is based on 
cost 

The turnover may be figured accurately according to either 
of two methods: (1) by dividing the cost of inventory into 
the cost of sales; (2) by dividing the total sales by the value 
of the merchandise at the sales price. If, for the purpose of 
illustration, we assume that in the case above mentioned the 
merchant has realized a net profit of 25 per cent, we find that 
he has actually turned his stock but four and one-half 
times: 


1. Based on Cost 

Value of merchandise inventoried at cost. $ 5,000 

Cost of sales ($30,000 less 25% profit). 22,500 

Turnover. AV2 times 






142 


SAFEGUARDING PAYMENT IN SALE OF GOODS 


2. Based on Sales Price 


Sales price of $5,000 merchandise. $ 6,666 

Total sales. 30,000 

Turnover. 4^4 times 


When compared with the average turnover in the industry 
as a whole, the turnover of an individual enterprise serves as 
an index of relative business efficiency. If the turnover in a 
given case is found to be below the average, it would tend to 
indicate one of four things: 

(a) The inventory, or merchandise, has been overvalued. 

(b) Too large a stock is being carried. 

(c) It partly consists of old, unmovable stock. 

(d) The selling efficiency of the merchant is below aver¬ 

age. 

2. The merchant’s ability as a collector may be estimated 
by making a comparison of the accounts receivable with the 
annual sales, based on the terms of payment, thus: 


Accounts receivable. $12,000 

Annual sales. 144,000 

(Monthly sales $12,000) 

Trade terms. 30 days net 


The accounts receivable should run approximately $12,000 
a month, showing the merchant in this case to be a very good 
collector. When the receivables seem unduly large and out of 
proportion, the presumption arises that the amount listed on 
the financial statement includes a number of old and uncollec¬ 
tible debts. 

3. By making a comparison of present figures with the 
corresponding figures reported for previous years it is possible 
to tell whether the business is progressing or retrograding (see 
Chapter XV). 

4. When available, a comparison may be made of the total 
expenses with the volume of sales, which affords a criterion 
whereby to judge whether or not the business expenses are 








VALUATION OF ASSETS AND LIABILITIES 


143 


in proper proportion to the gross profits, that is, whether the 
merchant is making a net profit. 

5. A comparison of his average monthly sales with the 
amount of stock carried will tend to show whether he is a care¬ 
ful buyer, or has a tendency to overbuy—so often the direct 
cause of insolvency. 


CHAPTER XII 


ANALYSIS OF CORPORATE FINANCIAL 

STATEMENTS 

Statements Defined 

The two principal financial statements compiled by a cor¬ 
poration are the balance sheet and the income or profit and 
loss statement, the purpose of both being fundamentally the 
same, namely, to show the actual condition of the business at 
a given time, in highly condensed, though in different forms. 

The balance sheet shows the financial condition of a corpo¬ 
ration at a particular time, and from a technical point of view 
purports to show the assets which it owns together with, and 
in contrast to, the liabilities which it owes. It indicates the 
solvency of the business but gives no information as to the 
earnings or expenses of operation. 

The income or profit and loss statement accounts for and 
explains the changes that have taken place in the finances of 
the business since the date of the last balance sheet. Theoreti¬ 
cally, it is supposed to supplement the balance sheet. 

Relation to One Another 

It is a well-established fact that the powers of even the 
most gifted are limited, and as the true condition of the busi¬ 
ness is determined not by any particular item of information 
but by the relation that exists between numerous items, the 
elimination of unnecessary details from the face of the balance 
sheet serves to facilitate the analysis whereby the relation is 
ascertained. It is therefore important to supplement the main 
statement or balance sheet, when possible, with the more de¬ 
tailed information contained in the income or profit and loss 


144 


CORPORATE FINANCIAL STATEMENTS 


145 


statement, as a means of explaining the various items that 
appear on the former. These two basic reports are, therefore, 
complementary to each other and of most value when studied 
together. While the credit man is principally concerned with 
the former in extending credit, it is because it as a rule is the 
only one of the two reports that is available, and not because 
of any lack of interest in the other. 

The difference in the situation reflected in these two state¬ 
ments has been likened unto the measurement of the contents 
of a tank of water from time to time. Assuming an inflow 
and an outflow pipe, changes in the volume of water may be 
determined either: (1) by comparing the actual level of the 
water for different periods; or (2) by comparing the total in¬ 
flow with the total outflow. 

Construction of the Balance Sheet 

The ultimate purpose of the balance sheet, as previously 
stated, is to show the relation that exists between the assets and 
liabilities as of a given time. Struck off at certain intervals, 
the balance sheet has been said to present a kind of “cross-sec¬ 
tional view” of the business condition at these intervals, 
inasmuch as it records the gains and losses, which may be due 
to either a change in the value of the assets or to an opposite 
change in the amount of the liabilities, or to both. 

Knowing the purpose a balance sheet is to serve, the next 
problem is as to the manner in which the information may be 
set forth to greatest advantage to accomplish this purpose. All 
credit men are more or less familiar with the construction of 
the typical balance sheet, and yet even experienced credit men 
are frequently confronted with statements containing items of 
undiscernible meaning, but the mystifying character of which 
quickly disappears when the true function of the item in ques¬ 
tion is ascertained and understood. This is true as to both 
assets and liabilities. 

The present-day tendency is for corporations to publish 


! 4 6 SAFEGUARDING PAYMENT IN SALE OF GOODS 


their balance sheets regularly at periodic intervals, owing to 
the increasing demand for publicity in connection with cor¬ 
porate affairs, and as a result the balance sheet has become 
one of the principal criterions upon which credit men base 
their inferences and conclusions in determining the inherent 
risk in extending credit to corporations. 

Assets 

Corporate assets naturally fall into three classes, based upon 
the manner in which they function within the business : 

1. Those of a permanent or fixed nature, which the busi¬ 

ness has acquired and which undergo but slight change 
from month to month or year to year, designated 
“fixed” assets, such as real estate and improvements 
thereon, equipment, and fixtures. 

2. Another class consists of those assets which are readily 

available and used for the purpose of discharging 
current liabilities incurred in the operation of the 
business, and are therefore termed “current” or 
“quick” assets, such as cash, accounts receivable, 
notes receivable, and the inventoried merchandise. 

3. The third class consists of credits which have been 

obtained as a result of certain payments made for 
benefit of future periods, or certain fixed charges 
paid in advance, which are called “deferred” assets, 
such as taxes, interest, and insurance premiums paid 
in advance. 

Arranged in statement form, the construction of the asset 
side of a corporate balance sheet may therefore be outlined as 
follows: 

Fixed Assets 
Land 
Buildings 
Equipment 
Fixtures 


Corporate financial statements 


147 


Current Assets 
Cash 

Accounts Receivable 
Notes Receivable 
Merchandise 

Deferred Assets 
Taxes Paid in Advance 
Rent Paid in Advance 
Interest Paid in Advance 

Liabilities 

On the liability side of the balance sheet we find classified 
in a very similar manner the debts of the corporation under 
the corresponding headings of: (1) “fixed” liabilities, or those 
which do not have to be met in the immediate future, such as 
mortgage debts and bonds; (2) “current” liabilities, or those 
which have to be met promptly and paid out of the current 
assets, such as accounts payable and notes payable; and also 
(3) what are termed the “capital” liabilities, or the par value 
of the outstanding capital stock and surplus. These capital 
liabilities constitute a secondary rather than a primary liabil¬ 
ity—corresponding to the net proprietorship, or what the busi¬ 
ness owes to the proprietor—but inasmuch as they partake of 
the nature of a liability, they are properly classified as such. 

The liability side of the balance sheet may, therefore, be 
outlined as follows: 

Fixed Liabilities 
Mortgage Bonds 

Current Liabilities 
Accounts Payable 
Notes Payable 
Accrued Taxes 
Accrued Rent 

Capital Liabilities 
Common Stock 
Preferred Stock 


148 safeguarding payment in sale of goods 


Of course, all balance sheets do not conform strictly to 
this general outline, but whatever variations are presented will 
be found to be differences of terminology and form rather than 
of principle or substance. 

Corporate Surplus 

The excess of the total assets over the total liabilities as 
thus classified will therefore represent the surplus, or credit 
balance of the business. So in order to bring the statement 
into balance it is necessary to add this amount to the listed 
liabilities. In other words, the surplus is an excess of assets 
carried as a nominal liability merely to bring the statement 
into balance and connotes profits from prior business dealings. 

Net Worth 

The net worth of any corporation is that amount which is 
the difference between the sum of all the assets and the liabili¬ 
ties, and it is determined by adding together the capital stock 
outstanding, surplus, accumulated profits, and surplus reserves. 
The resultant also incidentally represents the total book value 
of the shares of stock outstanding. 

If the sum of the liabilities, exclusive of the capital stock 
outstanding, the accumulated profits, and the surplus, exceeds 
the sum of the assets, the difference is the amount by which 
the capital stock outstanding has been impaired. 

Theory of Analysis 

Once the theory of the construction of a corporate balance 
sheet is understood, the analysis whereby the desired informa¬ 
tion is obtained is not difficult. In fact, the theory of the 
analysis of the corporate statement is substantially the same as 
the theory that has been set forth in a preceding chapter as 
applied to the ordinary property statement submitted by a 
partnership, unincorporated association, or the sole proprietor 
—the process whereby two things are ascertained: 


CORPORATE FINANCIAL STATEMENTS 


149 

1. The factors insuring the prompt payment of one’s ac¬ 

count as the bills fall due. 

2. The protection afforded by the equity in the fixed assets 

in event of an ultimate forced liquidation of the busi¬ 
ness—the ultimate payment of the account, however, 
being of less immediate concern than the regular 
payment of one’s bills as they fall due. 

The manner in which this information is obtained is also 
fundamentally the same as in the other forms of business. 
The former of the two propositions, as previously explained 
(see page 123), is directly dependent upon the amount of 
working capital available for the handling of one’s account, 
and is determined by ascertaining the difference betweeen the 
current assets and the current liabilities, as so classified in the 
statement, the current assets usually consisting of: 

Cash 

Merchandise 
Raw Materials 
Goods in Process 
Accounts Receivable 
Notes Receivable 

The current liabilities usually consist of: 

Accounts Payable 
Notes Payable 
Accrued Taxes 
Accrued Rent 

The importance of giving first consideration to the current 
assets has already been discussed, the reason for it being that 
the credit man must primarily look to them for the regular 
payment of his account. Insolvency is just as likely to result 
from the inability of an otherwise strong corporation to meet 
its current expenses because of insufficient cash as in the case 
of a partnership or that of a sole proprietor. In a similar 
manner the equity in the fixed assets is also determined by 


I 5 0 SAFEGUARDING PAYMENT IN SALE OF GOODS 

ascertaining the difference between the fixed assets and the 
fixed liabilities, as so classified on the statement. 

Before arriving at a decision as to the true status of the 
corporate finances, however, due consideration should also be 
given to such other items as the deferred assets, reserves, and 
accumulated surplus, the significance of which and the extent 
to which they enter into and modify the primary conclusions 
arrived at by the credit man will become more apparent after 
these various items have been discussed in detail. 

Factors Determining the Amount of Working Capital 

How is it possible to calculate in advance the amount of 
working capital required in a business, and upon what factors 
does this determination depend? Owing to the fact that the 
proportion of working capital required in certain lines of busi¬ 
ness is greater than the proportion required in other lines, it is 
not possible to prescribe an exact formula in answer to this 
question, but there are certain well-recognized factors that must 
be taken into consideration, which are as follows: 

1. Volume of Business. Other things being equal, the 
proper proportion of working capital in a business will vary 
in proportion to the volume of sales. Or, to put it in another 
way, the larger the volume of business transacted the greater 
the amount of cash capital required. 

2. The Regularity with Which Business Can Be 
Obtained and Disposed Of. Where the nature of the busi¬ 
ness is such that the volume of sales remains more or less 
constant throughout the year the regular income takes care of 
the regular outgo; but where the business is of a seasonal 
nature, it is quite obvious that a larger amount of working 
capital is required during the dull season, if the merchant has 
an accumulated stock on his hands, than during the active 
season when his stock is low. This factor increases the com¬ 
plexity of the situation and greatly affects the amount of 
working capital needed in a business. 


CORPORATE FINANCIAL STATEMENTS 


151 

3. Length of Period of Production. A business in 
which a long period is required to turn out the product requires 
that large amounts of working capital be tied up in the process 
of manufacture. This consequently constitutes another impor¬ 
tant factor in determining the amount of working capital 
needed in a business. “A breadmaker does not risk as much 
in proportion to the volume of his business as does the leather 
manufacturer, for he has scarcely paid for his flour and labor 
before the receipts from his sales flow back to him.” 

4. Terms of Purchase. Consideration must also be 
given to the terms of credit upon which the company purchases 
its goods, for it is obvious that where a concern sells its product 
on longer credit terms than it receives from the firms it pur¬ 
chases from, a greater amount of working capital is required 
than where the contrary is true. 

(a) Suppose A makes it a practice either to pay cash, or 
within the discount period, for the goods he carries in stock, 
while he resells them on 30 days’ credit. 

(b) Suppose B purchases the goods he carries in stock on 30 
days’ time and resells them for cash. 

Obviously, the amount of working capital required by A 
to finance his business will be greater than the amount re¬ 
quired by B. 

5. Terms of Sale. As a corollary to the principle estab¬ 
lished in the preceding section, it may be added that “the longer 
the period of credit extended in the resale of the product, the 
larger must necessarily be the amount of working capital 
required.” This factor becomes of special importance in con¬ 
sidering the amount of working capital required in an enter¬ 
prise that is concerned principally in the sale of its product in 
foreign countries. 

6. Hazards of the Business. Where the nature of the 
product is such that it is subject to frequent and violent market 
fluctuations, an ample reserve supply of working capital is 
necessary to serve as a protection against unlooked-for losses 


I 


152 SAFEGUARDING PAYMENT IN SALE OF GOODS 

due to market declines, and to carry the business through 
periods of liquidation. 1 

Valuation of Balance Sheet Items 

After the amount of working capital in the business has 
been determined, and likewise the prima facie equity in the 
fixed assets, the credit man should proceed with his investiga¬ 
tion until he has clearly established the true relationship that 
exists between the assets and liabilities. This involves a fur¬ 
ther consideration of the various items that usually appear on 
a corporate balance sheet. 

The nature, character, and function of the current and fixed 
assets, together with the current and fixed liabilities, has al¬ 
ready been fully discussed in the preceding chapter, so our 
further consideration of the subject may be restricted to those 
items which have not previously been discussed, particularly 
the capital and surplus liabilities which are pregnant with sig¬ 
nificance and usually merit the most careful consideration. 

Intangible Assets 

It is the common practice of accountants to include under 
the general term “fixed” assets, such items as good-will, 
patents, franchises, etc., all of which are of an intangible 
nature as distinguished from the other assets. Concerning the 
valuation of good-will as a business asset, one writer has said: 

The measure of value, in pecuniary terms, of this intangible 
thing, is the difference between the value of the normal results 
of the working of any business or profession which may be 
established by, and as worked by, any person in any place, and 
the result of working any individual business of a similar char¬ 
acter. Thus, given a business, the good-will of which is for 
disposal, there would be no valuable good-will if any one could do 
just as well by establishing a business anew. To start a busi¬ 
ness has its risks, which may often be described as very serious 
risks, but apart from the mere perilous risks of failing to take 


iSee Lough’s Business Finance, Chap. XVII. 



CORPORATE FINANCIAL STATEMENTS 


J 53 


proper root, there is the often weary time—sometimes a long 
term of years—during which a sufficient connection is being 
got together to bring the business up to a standard paying basis 
which will give a good-will value, or bring a good-will value into 
sight. To be spared this period of what I may call perilous 
probation is something worth paying for, even though its main¬ 
tenances from this point needs the continuous energy and indus¬ 
try by which it was built up by the original proprietor. Time, 
money and anxiety saved is money made. This is what is 
worth paying for, and in this degree a good-will value attaches 
to an established business. 

That such resources are valuable assets in a business is not 
to be questioned; but from the point of view of the credit man 
in extending credit, they constitute a negative quantity because 
to a going concern they are not available for debt-paying, and 
to an insolvent concern they are usually worthless. 

Capital Liabilities 

When a corporation first comes into existence, the initial 
funds with which it is to function are obtained from the issue 
of capital stock and possibly the sale of bonds. The funda¬ 
mental distinction between these two corporate instruments is 
that bonds are the corporation’s debts, while the capital stock of 
a corporation represents the aggregate ownership therein, and 
is usually, although not necessarily, divided into units called 
“shares”—each share representing a contract between the 
holder of the share certificate and the corporation. This con¬ 
tract does not provide for the repayment of the par value or 
purchase price of the share at any specified time, but repre¬ 
sents an agreement whereby the holder is to participate and 
share in the profits of the business in relative proportion to his 
capital holdings. If there is no binding promise on the part 
of the corporation to repay the par value of the share, why 
should the capital stock as represented thereby be considered 
and listed as a corporate liability? Because of the underlying 
theory that upon the disssolution of the business the par value 



154 SAFEGUARDING PAYMENT IN SALE OF GOODS 

of the stock, together with a pro rata share of the surplus re¬ 
maining, will be returned to the stockholders. 

Capital Stock 

The amount of this item should represent the face value of 
stock issued and outstanding. Sometimes, however, it includes 
the face value of all the stock authorized to be issued, even 
though some of the stock remains unissued. Stock which has 
been issued and later purchased back or returned to the corpora¬ 
tion should be shown as a separate item on the asset side of the 
balance sheet as treasury stock. Treasury stock, from the 
credit man’s viewpoint, may be considered as an asset only so 
long as the company continues prosperous or remains in a 
healthy financial condition, for in case of insolvency the 
treasury stock would become worthless. 

The stockholders are not creditors of a corporation inas¬ 
much as no legal responsibility for the return of the money to 
them rests on the company and in event of insolvency the gen¬ 
eral creditors must be paid before anything is realized out of 
the assets by the stockholders. Capital is, therefore, neither 
an asset nor a liability within the strict meaning of these terms. 

When the true liabilities are deducted from the true assets, 
the result represents the undivided profits plus the capital; and 
as dividends may only be paid out of the surplus or undivided 
profits, the capital must be deducted before dividends can be 
declared. Where, however, a certain amount of the surplus 
has been appropriated to the business and is not available for 
dividend distribution, it is generally carried as a separate item, 
“capital surplus.” 

Furthermore, the capital of a corporation does not repre¬ 
sent a trust fund in the ordinary sense of the word. The 
assets of a corporation are not held in trust either for the 
stockholders or creditors. It constitutes a trust fund only in 
the sense that it must first be accounted for before dividends 
are declared. A corporation owns property just like an in- 


CORPORATE FINANCIAL STATEMENTS 


155 


dividual, and it can do with it as it pleases so long as it does 
not become insolvent. But before any money in the nature of 
dividends is paid to the stockholders, the capital must be kept 
intact. It is the sole security on which a creditor can rely. 

. Bonds 

A corporate bond is a capital obligation of different char¬ 
acter. It is a corporate liability in the strict sense, being a 
promise under seal to pay a specified sum of money (the 
amount of the bond) at a fixed future time (usually more than 
ten years after the promise is made), and carrying a fixed rate 
of interest. As security for the faithful performance of such 
promise a so-called “deed of trust,” or mortgage, may be exe¬ 
cuted, whereby a certain portion of the corporate property is 
mortgaged to a trustee for the benefit of the bondholders. 
Consequently, if there is a bonded indebtedness the time of ma¬ 
turity of the bonds must be considered, also whether or not 
their payment is being provided for by means of an accumu¬ 
lated fund for their redemption. 

Reserves 

There are three classes of reserves as follows: 

1. Valuation reserves which are merely offset to assets 

and not really liabilities, such as depreciation reserves. 

2. Reserves which are liabilities in the strict sense of the 

term, such as the reserve for taxes. 

3. Reserves which in reality constitute a part of the sur¬ 

plus, such as the reserve for contingencies. 

Depreciation is a cost that is not always provided for in 
such manner, and as a result it has been known to become a 
source of serious financial embarrassment to the corporation. 

Surplus 

In the case of the partnership or sole proprietor the net 
worth, or excess of the total assets over the total liabilities, 


156 SAFEGUARDING PAYMENT IN SALE OF GOODS 


“ Large assets are not al¬ 
ways necessary to the crea¬ 
tion of credit; what is most 
desirable is that credit be in 
relative proportion to the ac¬ 
tual assets.” 


PROPERTY STATEMENT 

TO 


“The giver of credit is a 
contributor of capital, and be¬ 
comes, in a certain sense, a 
partner of the debtor, and, as 
such, has a natural right to 
complete information of the 
debtor’s condition at all 
times.” 


Form Adopted and Recommended by the National Association of Credit Men 

For the purpose of obtaining merchandise from you on credit, I (we) make the following statement in 
writing, intending that you should rely thereon respecting my (our) financial condition as of (Date) 


(All questions .should be answered. When no figures are inserted, write word “None.”) 


ASSETS 

Cash in hand. 



LIABILITIES 

For MERCHANDISE: 



Cash in bank. 



Accounts owing by customers, good 
and collectible, not pledged or sold. . 



Accounts owing past due. 



Trade Acceptances payable . 



Notes owing by customers, good and 
collectible, not pledged or sold. 



Notes payable for Mdse. 



For BORROWED MONEY: 

Notes payable to banks. 



Trade Acceptances receivable, not 
pledged or sold. 



Notes or debts payable to others 
(including relatives and friends). . . 



Merchandise: (not on consignment or 
conditional sale.) (How valued; 
Cost. . . . Market. . ..). 



Deposits of money with us. (De- 
scribe). 



Other quick assets: 

(Describe). 



Owing for Wages and Salaries. 



Owing for Taxes (city, state and fed¬ 
eral) . . . 









Owing for Rental 






Owing for Insurance Premiums. 



TOTAL QUICK ASSETS 



TOTAL QUICK LIABILITIES 


— 1 





Machinery: (How valued; Cost. . . . 



Debt secured by mortgage on land or 
buildings. 



Depreciated. . . .). 



Fixtures and other Equipment. (How 
valued; Cost.... Depreciated. . . .) 

I-and and Buildings as described below 



Debt secured by chattel mortgage or 
other liens. 





Debt secured by judgment. .. 





Other liabilities: 

(Describe). 



Notes and Accounts owing from mem¬ 
bers of firm, employees, or others not 






customers. 

Other assets: 

(Describe). 



TOTAL LIABILITIES 

(•Capital ( Preferred. 
NET WORTH / Stock (Common. 













^Surplus and Und ._ 

( vided Profits. 



TOTAL ASSETS 





TOTAL 








What books of account do you keep?. 

Was this statement made from those books?. Do you keep cost records?. .. .. . . 

Do you sell or pledge your accounts to creditors, banks, finance companies or others?. ....... If so, what 

amount is so sold or pledged? $ . What amount of your accounts have you sold or pledged 

during the past twelve months? $ . 

Are any creditors secured by mortgage or lien or any sort?. If so, how?.. 


Are any claims in attorneys’ hands or suits against you?. 

Have you merchandise on consignment or conditional sale?. If so, what amount? $ 

If business property is leased, for what term and what rental?. 

Name and locality of your bank or banks. 

Location and kind of business. 

Is your business incorporated?. If so, under laws of what state?. 

Previous business experience. Where 


. j 11 ^ every Question on both sides of this sheet be correctly answered and that the blank* * 

y filled in. In answering questions involving amounts write the word “none” where figures do 

aM° U J»at d a ,t ye a a d r V £ a cl'° US l ° ““■> » «» compaSSa 

* Capital stock item to be filled out only by corporations. 


Form 7. Standard Form of Corporation Balance Sheet 





















































































CORPORATE FINANCIAL STATEMENTS 


157 


INSURANCE 

On Merchandise $ . On Buildings J. Machinery $ . Fixtures $ 

Other Equipment $ . Employers’ Liability $ . 

Is any insurance assigned?. What amount?. To whom?. 

Amount of life insurance for benefit of business $ . 

With what companies. 


SUMMARY OF PROFIT AND LOSS 


Inventory of Mdse, beginning of fiscal 
year (not including fixtures or equip¬ 
ment) . 



Sales last fiscal year. 

Income from all other sources. 

Inventory of Mdse, at close of year. . 



Cost of Mdse, purchased during the year. 
General expenses including salaries, 
losses, etc. 



Total Income for year. 

Less Total Expenses... 



TOTAL EXPENSES. . . . 



NET PROFIT FOR YEAR. . . . 




RECORD OF LAND AND BUILDINGS 


Title in name of 

Description 
and location 

Book 

value 

Assessed 

value 

Amount of 
Encumbrances 

To whom 
































BUY PRINCIPALLY FROM THE FOLLOWING CONCERNS 


Names 

Addresses 

Amount Owing 

Open Account 

Notes 






































Names and Addresses of Partners, or if Corporation, of Officers 


REMARKS: 

The foregoing statement has been carefully read (both printed and written matter) and is in all respects 
complete, accurate and truthful. It discloses to you the true state of my (our) financial condition on the 
date above stated. Since that time there has been no material unfavorable change in my (our) financial 
condition; and if any such change takes place I (we) will give you notice. Until such notice is given, you are 
to regard this as a continuing statement. 

Name of Individual, Firm or Corporation... 

Signed by. 

Street.Town.State. 

Date of signing statement.19.... 

Form Jt. 


Adopted by the National Credit Men’s Association 
















































































158 SAFEGUARDING PAYMENT IN SALE OF GOODS 


represents a sort of secondary liability—what the business owes 
the proprietory or proprietors, so to speak. Corresponding 
to such a secondary liability in the case of the partnership or 
sole proprietor, we have the “surplus” item carried on the cor¬ 
porate balance sheet, which, to carry out the analogy, may be 
said to represent the accumulated profits available for distribu¬ 
tion among the stockholders. No legal duty, however, rests 
upon a corporation to distribute its surplus; it is a discretionary 
power vested in the board of directors. Neither the proprie¬ 
torship or the surplus item is a liability in the strict sense, 
because it is not a debt the payment of which may be forced 
by process of law. It is merely a nominal liability. 


Form of Corporate Balance Sheet 

Considerable latitude is permitted in drawing a corporate 
balance sheet. An approved simple form and one very fre¬ 
quently adopted is the following: 


Assets 

Capital Assets 

Land. $ 

Buildings. 

Machinery and Equip¬ 
ment . 

Furniture and Fixtures. . 
Good-Will, Patents, etc.. 

Current Assets 

Finished Goods. 

Raw Materials. 

Cash. 

Accounts Receivable.... 
Notes Receivable. 

Deferred Assets 

Prepaid Taxes. 

Prepaid Insurance. 

Prepaid Rent. 


Liabilities 

Capital Liabilities 

Bonds. $ 

Preferred Stock. 

Common Stock. 

Current Liabilities 

Accounts Payable. 

Notes Payable. 

Owing to Banks. 

Accrued Wages, Rent, 
etc. 

Reserves 

Depreciation of Equip¬ 
ment . 

Depreciation of Buildings 
For Doubtful Accounts.. 
Surplus. 


Form 8. Balance Sheet of a Corporation 

The National Credit Men’s Association has adopted a 
standard form of statement for the use of corporations. This 
is shown in Form 7 on pages 156 and 157. 






































CHAPTER XIII 

> 

INCOME OR PROFIT AND LOSS STATEMENT 

Function of the Statement 

The income or profit and loss statement, when available, 
yields certain information to the credit man that cannot be 
obtained from a balance sheet, because it is conditioned upon 
a more detailed and extended statement of facts. The volume 
of business done, the yearly turnover, the operating ratio— 
these and various other items of interest to a credit man can 
be derived from an income statement, when properly analyzed. 

Once obtained this statement ought always to be preserved 
and used as a basis for comparison with those submitted later 
in order to determine the underlying trend or tendencies of the 
business. Taken over a period of several years, well-defined 
tendencies or constructive policies in the conduct of the busi¬ 
ness are unmistakably reflected in the changes that are 
recorded in the income statement, because it sets forth in 
analytical form the sources of both profits and losses, and the 
ultimate profit or loss, as the case may be. A balance sheet 
does not purport to account for the direct sources of profits 
and losses, its exclusive function being to show the effect upon 
the classified assets and liabilities of the changes that have 
transpired in the business finances during the interval as 
accounted for by the income statement. 

Construction of the Profit and Loss Statement 

The following outline may be considered as the most com¬ 
mon or typical form of corporate income statement. It starts 
out with the gross earnings, or the amount realized from the 
gross sales of its product, and proceeds in orderly manner to 

159 


i6o SAFEGUARDING PAYMENT IN SALE OF GOODS 


add and deduct the various sources of revenue and expense 
until a correct balance, representing the corporate surplus, is 
arrived at. 


i. Amount Realized on Gross Sales. $100,000 

Deduct: Cost of the Goods Sold. 4°» 000 


2. Gross Profit on Sales. $ 60,000 

Deduct: Selling Expenses: 

Salaries. $. 

Traveling Expenses. 

Commissions. 

Advertising, etc. 25,000 


3. Selling Profit. $ 35,000 

Deduct: Administrative Expenses: 


Salaries of Officers. $. 

Salaries of Employees. 

Directors’ Fees. 

Printing and Stationery. 

Telephone and Telegraph. 

Legal Services, etc. 15,000 


4. Net Return from Operations. $ 20,000 

Add: Other Income: 

Interest on Securities Owned. $. 

C/D on Purchases. 

Interest on Bank Balances, etc. 10,000 


5. Total Income or Earnings. $ 30,000 


Deduct: Fixed Charges: 
Interest on Bonds. . . 
Interest on Notes... , 
Insurance. 


Taxes, etc. 5,000 

\ 

6. Net Earnings. $ 25,000 

Deduct: Reserves: 

Depreciation for Doubtful Accounts. $. 

Depreciation of Equipment. 

Depreciation of Buildings. 5 1 000 




























































INCOME OR PROFIT AND LOSS STATEMENT 


161 


7. Profit and Loss Surplus (for Year-to-) 

Add: Profit and Loss Surplus from Previous Years 


20,000 
10,000 


8. Gross Surplus. 

Deduct: Dividends Declared 


$ 30,000 
10,000 


9. Present Corporate Surplus 


$ 20,000 


Reduced 
set forth as 


to its simplest form, the income statement may be 
follows: 


Gross Sales or Income. $ 

Operating Expenses. 


Net Income. $ 

Fixed Charges. 


Surplus for Year. $ 

Surplus from Previous Years.. 


Corporate Surplus. $ 

Gross Sales or Earnings 

Gross sales or earnings, strictly speaking, includes only the 
income derived from the concern’s principal line of business. 
Income from collateral or supplemental sources, such as that 
from securities, rentals, etc., is properly included in the sepa¬ 
rate item, “other income,” which, when added to the difference 
between the gross sales and the operating expense, gives the 
“total income.” 

Gross sales may be said to measure the success of the busi¬ 
ness to the extent that they will promptly reflect any decline 
in prosperity. In other words, they are large or small, and 
increase or decrease in direct proportion to the success of the 
business, which in turn largely depends upon the rapidity with 
which the merchandise is turned over. The reason for this is 
that an increase in the rate of turnover not merely increases 




















162 safeguarding payment in sale of goods 


the gross income, but it also reduces the proportionate expense 
of handling the merchandise. It simply represents another 
phase of the economic law of increasing and decreasing 
returns as applied to the sale of merchandise, for rarely does 
the expense of doing business increase proportionately with 
the growth of sales, and rarely, on the other hand, does it 
decrease proportionately with a falling off of sales. This is 
true because many charges, such as taxes, depreciation, etc., 
remain approximately the same in amount irrespective of the 
volume of business transacted. 

The significance of this item to a credit man is that changes 
in the volume of income should be carefully noted and studied 
in the light of existing and probable future business conditions. 

Gross sales should include all goods sold during the period 
under consideration, as modified, however, by goods returned 
and price adjustments. 

In order to determine the efficiency of the business manage¬ 
ment, a comparison is made between the total volume of sales 
and the amount of the final inventory, on the theory that the 
presence of an unusually large inventory would tend to indicate, 
although not necessarily, poor management in permitting the 
unsold stock to accumulate in excess of the market demand for 
the goods. For example, assuming that a corporation reports 
annual sales amounting to $500,000, and the merchandise on 
hand at the end of the period amounting to $200,000, the 
natural inference would be that the concern was carrying too 
large a capital investment in stock-in-trade. This is, of course, 
merely an inference and by no means to be taken as conclusive 
evidence of inefficiency, because it is entirely possible that such 
a condition may reflect efficiency instead of inefficiency on the 
part of the management in stocking up merchandise at ad¬ 
vantageous prices for use in supplying a later period—antici¬ 
pating the market, so to speak. 

However, such a condition discloses what is commonly re¬ 
ferred to as “speculation in inventory,” which may be said to 


INCOME OR PROFIT AND LOSS STATEMENT 163 

consist in the purchase of a larger quantity of merchandise than 
will be consumed by normal sales within a reasonable period. 
A large inventory always lays a business open to the danger of 
large losses from the shrinkage of market values. 

Cost of the Goods Sold 

The cost of the goods sold is found by taking the inven¬ 
tory of finished goods on hand at the beginning of the period, 
adding the cost of the goods manufactured during the period 
under consideration, and then deducting the value of the fin¬ 
ished goods on hand at the end of the period. In the equa¬ 
tion form the formula is as follows: 

Cost of goods sold = Goods on hand at beginning of period + 

Cost of goods manufactured during period—Volume of finished 
goods on hand at end of period. 

The formula may be put in another form of equation, thus: 

Cost of goods sold = Cost of goods manufactured-{-Difference 

between inventory of finished goods at the beginning of period 

and that at end of period. 

This item, cost of goods sold, is also used as the basis for 
calculating the turnover of the capital invested in merchandise, 
by dividing it by the merchandise inventory, as already shown. 
Manifestly, the greater the rate of turnover the larger the 
return on the capital investment. Consequently, the turnover 
may be accepted as an authentic criterion of the management’s 
business efficiency when compared with that of preceding 
periods. 

Gross Profit 

As shown by the outline, the difference between the income 
from sales and the cost of the goods sold represents the gross 
profit on sales. In determining the percentage of gross profit 
on sales, either the cost of the goods sold or the gross sales 
may be used as a basis. The result, however, is of particular 
significance only as a comparative figure and when taken into 


164 SAFEGUARDING PAYMENT IN SALE OF GOODS 

/ 

consideration with the corresponding figure of prior periods. 
When so used it will disclose either an increase or decrease in 
the percentage of gross profit, and the reason for the change 
is always of interest to a credit man. 

Selling Expenses 

This item should include all the expenses of marketing and 
distributing the goods sold. In examining this item, the credit 
man should consider it in comparison with the volume of sales, 
in order to determine whether or not it is in proper proportion. 
If it is found to be too large, a logical inference is that the 
business is being carried on under too great an overhead ex¬ 
pense and that it is organized on an unprofitable basis. Too 
great reliance is not to be placed on this figure, however, be¬ 
cause there is no uniform basis for calculating selling expenses, 
and the problem is primarly one of accurate cost-finding. 
Given, however, a uniform cost system over an extended 
period, any appreciable increase or decrease in the percentage 
of sales expense becomes significant. 

Administrative Expenses 

The next group of expenses are those which have to do 
with the management of the enterprise. They are made up 
of those expenses which cannot be directly apportioned either 
to manufacturing or selling activities, but the benefit of which 
accrues to both branches of the business. 

In connection with this item it is important to know that 
the cost of supervising the establishment bears a proper rela¬ 
tion and is in proper proportion to the cost of manufacture, the 
selling expense, and the volume of sales; but in order to de¬ 
termine this, it is necessary, as a condition precedent, that the 
credit man should know approximately what constitutes an 
average overhead administrative expense of concerns engaged 
in similar lines of business. Once this is known, significant 
comparisons may be made. 


INCOME OR PROFIT AND LOSS STATEMENT 


165 

Summary 

So far we have seen that we start out with the gross income 
from sales, and then deduct the selling and administrative 
expenses, which taken together will hereafter be referred to 
merely as the operating expense. The result, as will be noted 
by reference to the outline, is what is termed the “net profit” 
from sales; or, as it will be hereafter referred to, the “net in¬ 
come.” These are the three important factors to be considered 
in analyzing a comparative income or profit and loss statement. 

Operating Ratio 

The item, “operating expense,” when construed in relation 
to the gross income, serves as a very useful basis of compari¬ 
son and an index to the business efficiency of the company, 
when made over different periods of a concern’s history, and 
also when used as a basis for comparing the relative efficiency 
of different companies engaged in the same line of business. 
The ratio of the operating expense to the gross income is 
termed the “operating ratio.” 


Example: 

Gross income reported to be.$100,000.00 

Operating expense. 60,000.00 

Operating ratio = 5:3 


This means that it costs the company on an average $3 to 
sell $5 worth of goods. 

As a rule, a decline in the operating ratio may be construed 
as indicating some improvement in the conduct of the business, 
such as would be reflected by an increased rate of turnover. 
This should be a mere presumption, however, as the decrease 
may have resulted from some temporary economy that is being 
practiced and which will ultimately prove detrimental rather 
than beneficial to the welfare of the business, such as, for 
example, the failure to set up a sufficient reserve for deprecia¬ 
tion. The value of the operating ratio for comparative pur¬ 
poses may be largely reduced by lack of a uniform system of 




166 SAFEGUARDING PAYMENT IN SALE OF GOODS 


accounting; but, on the other hand, if the corporation has 
maintained a uniform system of accounting over an extended 
period, valid comparisons may be made between two or more 
years. 

Interpretation of Net Income 

By deducting the operating expense from the gross income 
we obtain the net income, and it is from the net income that the 
fixed charges must be met. It is therefore obvious that if too 
great a proportion of the gross income is allocated to operating 
expenses, or the fixed charges are too great in proportion to 
the volume of business transacted, it is at least possible that 
the net income may be insufficient to meet the fixed charges. It 
is for this reason that bondholders generally require a margin 
of safety in the net income amounting to at least twice the 
sum required to pay the interest on the bonds. 

Net income also constitutes the primary source of dividends 
to be paid to stockholders, although when the corporation has 
set aside during years of prosperity a surplus for this particu¬ 
lar purpose, dividends may be paid out of the surplus when the 
net income proves insufficient. A striking illustration of this 
point is to be found in the financial policy of the American 
Car and Foundry Company, which during the war and post¬ 
war period set aside as a special appropriation a fund suffi¬ 
cient to maintain the regular dividend rate for several years. 
Unless such a special appropriation is set aside, the policy of 
paying unearned dividends out of the surplus, which is very 
common, may injuriously reduce the working capital of the 
business, and instead of serving to maintain their credit respon¬ 
sibility, may seriously jeopardize it. 

Other Income 

By adding the revenue from collateral sources, such as inter¬ 
est and dividends received on securities held, discounts on 
purchases, rents, royalties, etc., we obtain the total income. 


INCOME OR PROFIT AND LOSS STATEMENT 


167 

Any and all items of income, other than that derived from the 
sale of the company’s product should properly be included under 
“other income.” 

Fixed Charges 

The fixed charges are not likely to present any considerable 
misstatement of values, inasmuch as the determination of their 
amount is largely beyond the control of the management. The 
significance of this item lies rather in the comparative amount. 

Net Earnings 

By deducting the amount of fixed charges from the total 
income we get the net earnings; and in order to obtain the 
year’s surplus, all that remains to be done is to deduct the 
special reserves which have been established to cover depre¬ 
ciation, abnormal losses, etc. 

Corporate Surplus 

Assuming a surplus has been accumulated during prior 
years, by adding the year’s surplus to the surplus carried over 
at the beginning of the year, the gross corporate surplus is 
obtained, and should check with that item as shown on the 
balance sheet. 

Analysis of Surplus Fluctuations 

If the costs and expenses of the year have been greater than 
the total income received, the operations have resulted in a 
deficit. This not infrequently occurs, and occasions no great 
financial embarrassment to a corporation which has a surplus 
carried over from previous years. 

The conversion of such a deficit from operations into a 
surplus in the succeeding period, however, should be carefully 
inquired into. This might be brought about by inflation of 
the inventory, and if a comparison of the inventory showed 
that it had increased in a much greater degree than the increase 


168 SAFEGUARDING PAYMENT IN SALE OF GOODS 


in the accounts and notes payable, it could reasonably be 
inferred that an inflation of the inventory was responsible 
for the change. Comparative statements taken over a period 
of years will usually disclose practices of this sort where a 
statement for a single year would be useless. 


CHAPTER XIV 


LAWS ON PUBLICATION OF FINANCIAL 

STATEMENTS 

States Requiring Publication 

An examination of the corporation laws of the various 
states and territories of the United States discloses the fact 
that very few have enacted laws requiring corporations to pub¬ 
lish financial statements. Annual publication of corporate re¬ 
ports are required in these states and territories: 

Alaska 

Exceptions: Foreign corporations. 

Date of Publication: Within 30 days after date fixed for stockholders’ 
annual meeting. 

Nature of Publication: Newspaper of general circulation published 
nearest to place of transaction of business. 

Report Verified By: President and treasurer. 

For Failure to Publish: Such officers who neglect to publish after 
written request to do so by a creditor shall be under penalty of $50 
for every day in default, recoverable by aggrieved creditor. 

District of Columbia 

Exceptions: Domestic insurance corprations. Foreign corporations not 
exempt. 

Date of Publication: January 1-20. 

Nature of Publication: Newspaper in the district. 

Report Verified By: Oath of president or secretary. 

Report Signed By: President and majority of trustees. 

For Failure to Publish: Any creditor may by petition for mandamus 
against the corporation and its proper officers compel such publica¬ 
tion. Corporation or officers at fault must stand all expenses. 

Publication of False Report: If false in any material representation all 
officers who shall have signed the statement, knowing it to be false, 
shall be jointly and severally liable for all debts contracted while 
they are stockholders or officers. 

169 


I jo SAFEGUARDING PAYMENT IN SALE OF GOODS 


Nebraska 

Exceptions: Domestic religious societies, foreign corporations. 

Date of Publication: Annually. 

Nature of Publication: Newspaper of general circulation in the country 
where principal office of the corporation is located. 

Report Verified By: An oath of president and secretary. 

For Failure to Publish: No provisions. 

Publication of False Report: No provisions. 

Nevada 

Exceptions: Domestic corporations. 

Date of Publication: Not later than March of each year. 

Nature of Publication: Newspaper published in the state. If a daily 

# 

paper, publish for a week; if a semi- or tri-weekly paper, publish 
for 2 weeks; if a weekly paper, publish for 4 weeks. 

Report Verified By: No provision. 

For Failure to Publish: No provision. 

Publication of False Report: No provision. 

North Dakota and South Dakota 
Exceptions: Domestic corporations not engaged in mining, manu¬ 
facturing, or other industrial pursuits. Foreign corporations are 
not exempt unless engaged in pursuits not mentioned above. 

Date of Publication: January 1-20 

Nature of Publication: Newspaper published at or nearest to the place 
where the business is carried on. 

Report Verified By: Oath of president or secretary. 

Report Signed By: President and majority of directors. 

For Failure to Publish: Any person who wilfully neglects, fails, or 
refuses to make, sign, or publish the report is guilty of a misde¬ 
meanor. 

Publication of False Report: No provision. 

Tennessee 

Exceptions: Foreign corporations. 

Date of Publication: During month of January. 

Nature of Publication: Newspaper in county of principal office. 

Report Verified and Signed By: No provision. 

For Failure to Publish: No provision. 

• Publication of False Report: No provision. 

Summarizing, we find that Alaska, District of Columbia, 
Nebraska, Nevada, North Dakota, South Dakota, and Ten- 


LAWS ON PUBLICATION OF STATEMENTS 


171 

nessee are the only states or territories that require corporations 
to publish financial statements. 

Other Statutory Provisions 

There are a few other states, however, which have provided 
another way of protecting creditors, and that is by requiring 


Title of Official 

State with Whom Filed Date of Filing Corporations Exempt 


Alaska. Secretary of the Dis- Within 60 days from Domestic corporations 

trict January 1 

Arizona*. Corporation Commis- During June No exceptions 

sion 

Arkansas. County Clerk, county February 15 or August Foreign corporations 

where business trans- 15 

acted 

Colorado. Secretary of State Within 60 days after No exceptions 

January 1 

Hawaii. Treasurer of Territory Domestic corporations. Charitable, religious, 

within 60 days after literary, educational, 
January 1 or corporations pro- 

Foreign corporations, moting amateur ath- 
July 1 letics 

Kansas*. Secretary of State On or before March 31 No exceptions 

Massachusetts.... Commissioner of Cor- Within 3 months after No exceptions 

porations annual meeting 

Michigan. Secretary of State January or February No exceptions 

Missouri. Secretary of State On or before July 1 Express and insurance 

companies and com¬ 
panies exempt from 
taxation 

Montana. County Clerk in county By March 1 Domestic banks, trust 

where business is lo- companies, and 

ca ted building and loan 

associations 

New Hampshire. . Secretary of State By March 1 No exceptions 

New York. Secretary of State During January Railroad and moneyed 

corporations 

Ohio. Recorder of county During January No exceptions 

where business is lo¬ 
cated 

Pennsylvania*.... Auditor General On or before iast day Banks, insurance, and 

of February trust companies and 

building and loan 
associations 

Porto Rico... Treasurer of Porto By March 15 No exceptions 

Rico 

Vermont. Secretary of State By March 1 No exceptions 


* These reports are required for tax purposes. 





















172 SAFEGUARDING PAYMENT IN SALE OF GOODS 


corporations to permit creditors to examine such records and 
books of account that would be of direct importance to their 
claims. Missouri, New Hampshire (creditor’s attorney also 
has this right), and Oregon have made this provision in their 
corporation laws. 

A number of the states and territories require corporations 
to render financial statements to state officials, with whom they 
are recorded and filed. It is possible that such state officials 
might furnish creditors with copies upon receiving written 
request to do so. However, this point is not provided for in 
the statutes. The table on page 171 shows the states that 
have enacted laws requiring corporations to file financial state¬ 
ments, the title of the official with whom they must be filed, the 
date of filing, and the corporations exempt. 

Statements to Stockholders 

The following states require corporations to submit finan¬ 
cial statements to their stockholders of record: 

California. Upon the written request of not less than 10 per cent 
of the stockholders, given not less than two weeks before the annual 
election, the corporation must furnish each stockholder with a copy of a 
financial statement. 

Louisiana. Once every calendar year the corporation shall mail a 
statement of the last annual report to any stockholder requesting it. 

Maryland. Corporations must keep on file in principal office in the 
state a copy of the annual report for the use of the stockholders. 

Michigan. A true statement of accounts shall be exhibited to the 
stockholders at least once a year. 

Minnesota. When required, corporations shall present to the stock¬ 
holders written reports of the condition of the business. 

Missouri. All books of the corporation shall be open to inspection 
by the stockholders. 

Montana. Stockholders owning 5 per cent or more of the stock of 
a corporation must be furnished upon request with a complete statement 
of conditions. 

New Hampshire. Stockholders have a right to examine records and 
accounts of importance. 


LAWS ON PUBLICATION OF STATEMENTS 


173 


North Dakota. A statement of accounts shall be laid before the 
stockholders annually. 

New York. Corporations (except moneyed) must furnish a state¬ 
ment of affairs if requested by stockholders owning 5 per cent of the 
capital stock when not in excess of $100,000; or 3 per cent if in excess 
of $100,000. Corporations are not required to submit more than one 
such statement a year. A copy of any such statement must be kept on 
file in the office of the corporations for 12 months for the benefit of all 
stockholders. 

Ohio. Corporations must furnish each stockholder with a copy of 
an annual statement of its financial condition. 

Oklahoma. Once a year a statement of accounts shall be laid before 
the stockholders. 

South Carolina and South Dakota. Books of account shall be 
open at all reasonable times to the inspection of the stockholders. 

Wisconsin. At least once a year each corporation shall make and 
file in its principal office and keep on file there for the use of its stock¬ 
holders a report of its financial condition. 

Wyoming. Upon written request by any person or persons owning 
15 per cent of the capital stock of the company, such company shall 
make to that person or persons a statement of affairs. A copy of such 
statement shall be held on file in the principal office for a period of 6 
months. 

Oregon. All books of the corporation necessary for carrying on its 
business shall be subject to the inspection, at all reasonable hours, of 
any stockholder applying therefor. 

The following states have made no provision for: 

1. Publishing of financial statements of corporations. 

2. Rendering of such financial statements to state officials. 

3. Inspection of records and books of account by creditors 

or stockholders. 

4. Submitting of financial statements to stockholders. 


Alabama 

Connecticut 

Delaware 

Florida 

Georgia 

Idaho 

Illinois 


Indiana 

Iowa 

Kentucky 
Maine 
Mississippi 
New Jersey 
New Mexico 


174 SAFEGUARDING PAYMENT IN SALE OF GOODS 


North Carolina Virginia 

Rhode Island Washington 

Texas West Virginia 

Utah Philippine Islands 

False Statement Legislation—Federal Law 

A false statement may be defined as one which, by overesti¬ 
mating the value of the assets, omitting liabilities, improperly 
classifying items, or in some other way conveys the impression 
that the financial condition of the enterprise is otherwise than 
it in reality is. 

It should also be remembered in this connection that it is 
a crime to obtain money or property under false pretenses, or 
to use the mails to defraud. 

Section 215, of the United States Criminal Code, provides: 

Whoever, having devised or intending to devise any scheme 
or article to defraud, or for obtaining money or property by 
means of false or fraudulent pretenses, representations, or prom¬ 
ises, etc., shall for the purpose of executing such schemes or 
artifice, or attempting so to do, place, or cause to be placed, any 
letter, postal card, package, writing, circular, pamphlet, or 
advertisement, whether addressed to any person residing within 
or outside the United States, in any post-office, or station thereof, 
or street or other letter box of the United States, or authorized 
depository for mail matter, to be sent or delivered by the Post 
Office establishment of the United States, or shall take or receive 
any such therefro m, whether mailed within or without the United 
States, or shall knowingly cause to be delivered by mail accord¬ 
ing to the direction thereon, or at the place at which it is directed 
to be delivered by the person to whom it is addressed, any such 
letter, postal card, package, writing, circular, pamphlet, or ad¬ 
vertisement, shall be fined not more than one thousand dollars, 
or imprisoned not more than five years, or both. 

Consequently, all the envelopes in which the financial 
statements are received should be carefully preserved after 
having been dated and signed by the one who received the 
statement and by a responsible witness; for if a statement is 


LAWS ON PUBLICATION OF STATEMENTS 


175 


proved in any later development to have been purposely made 
false, the party is legally liable for obtaining goods under 
false pretenses, since the acknowleged purpose of such a report, 
it is always understood, is to afford a basis for the extension 
of credit and this precaution will prove of great value in offer¬ 
ing competent testimony that the mail was used to defraud. 

A rubber stamp is sometimes used for this purpose which 
reproduces the following phrase: 

This envelope received the.day of.192— 

contained the financial statement of. 

for . 

Witnessed: 

Signed: 

The envelope should then be permanently attached to the 
statement itself. When thus preserved such evidence is 
admissible in the prosecution of a case of fraud. 

State Laws 

It is to be noted that the above-quoted law covers only 
one particular class of cases in which a false financial state¬ 
ment has been sent through the mail service. The next step 
taken was made necessary by the rapid development and 
increased use of financial statements as a basis of credit, and 
its purpose was to safeguard creditors against those who would 
issue a false statement to secure credit. 

The general purpose of a false statement law is explained 
in its title, and the model false statement law is broad enough 
in scope to cover all cases of the making of false written state¬ 
ments to procure credit in any form, and whether made direct 
to the creditor or indirectly through the mercantile agencies. 
Moreover, it aims at the person who makes the statement or 
causes it to be made, whether such person seeks the credit 
for himself or for any other person, firm or corporation. 

Some form of special statute has been enacted in 32 states 
providing for the punishment of this class of offenders, when 
the offense is committed in such a way as not to come within 






176 SAFEGUARDING PAYMENT IN SALE OF GOODS 

the jurisdiction of the federal authorities, and these laws act 
as a strong deterrent force against those who might otherwise 
be tempted to make false statements. 

The New York law, enacted in 1912, is considered the 
model false statement law. In fact, it has been copied verbatim 
in a good many other states. It makes the provision that any 
person: 

1. Who shall knowingly make or cause to be made, either 
directly or indirectly, or through any agency whatsoever, any 
false statement in writing, with intent that it shall be relied upon, 
respecting the financial condition, or means or ability to pay, 
of himself, or any other person, firm or corporation, in whom he 
is interested, or for whom he is acting, for the purpose of pro¬ 
curing in any form whatsoever, either the delivery of personal 
property, the payment of cash, the making of a loan or credit, 
the extension of a credit, the discount of an account receivable, 
or the making, acceptance, discount, sale or indorsement of a 
bill of exchange, or promissory note, for the benefit of either 
himself or of such person, firm or corporation; or 

2. Who, knowing that a false statement in writing has been 
made, respecting the financial condition or means or ability to 
pay, of himself, or such person, firm or corporation in which he 
is interested, or for whom he is acting, procures, upon the faith 
thereof, for the benefit either of himself, or of such person, firm 
or corporation, either or any of the things of benefit mentioned 
in subdivision one of this section; or 

3. Who, knowing that a statement in writing has been made, 
respecting the financial condition or means or ability to pay of 
himself or such person, firm or corporation, in which he is inter¬ 
ested, or for whom he is acting, represents on a later day, either 
orally or in writing, that such statement theretofore made, if 
then again made on said day, would be then true, when in fact, 
said statement if then made would be false, and procures upon 
the faith thereof, for the benefit either of himself or of such 
person, firm or corporation, either or any of the things of benefit 
mentioned in subdivision one of this section. 

Shall be guilty of misdemeanor and punishable by imprison¬ 
ment for not more than one year or by a fine of not more than 
one thousand dollars, or both fine and imprisonment, 


LAWS ON PUBLICATION OF STATEMENTS 


l 77 


Where such a statute has been enacted, the only elements 
of proof required against the defendant are, according to the 
law, as follows: 

ist: That he made a statement; 

2d: That the statement is false; 

3d: That he made it with the intention that it should be 
relied upon; 

4th: That he made it for the purpose of securing credit 
in some form or other. 

It is clear that a statement may be false without being 
fraudulent; that is to say, it may be exaggerated without inten¬ 
tion to defraud anyone. It may be untrue in fact, but it may 
be made with innocent intent. The merchant may intend to 
continue business and pay for the goods. The new statute, 
however, stops precisely this thing and makes it a misdemeanor 
to make a false statement, even without fraudulent intent. It 
is based upon the same principle that makes the carrying of a 
deadly weapon a crime. If the weapon is used to commit mur¬ 
der, the defendant is guilty of murder, but we no not wait until 
he commits murder if we find him possessed of a deadly weapon. 

The possession of instruments of crime is made a crime, so as 
to deter the commission of more serious crime. Hence, the 
making of a false statement, even though without fraudulent 
intent, is made a misdemeanor. 

Several unsuccessful attempts have been made to have a 
national false statement law enacted which would apply to inter¬ 
state credit transactions in the same way the state false state¬ 
ment laws of the states apply to intrastate credit transactions. 

Section 215 of the Criminal Code would seem to be ade¬ 
quate to cover instances where the mail has been used to trans¬ 
mit a false statement for the purpose of procuring credit, but 
it is possible to conceive of instances which would not fall 
within its provisions or the provisions of the false statement 
law of some particular state, and yet give rise to a credit 
transaction of an interstate character; e.g., a merchant from 
New Jersey comes over to New York and personally submits 
£ false statement on the strength of which merchandise of the 


178 SAFEGUARDING PAYMENT IN SALE OF GOODS 

value of $1,000 is delivered to him in New Jersey. Assuming 
the fraud to have been committed in New York, the laws of 
New York have no exterritorial effect whereby a man can be 
prosecuted in New Jersey for a crime or misdemeanor com¬ 
mitted in New York. But assuming a national false statement 
law to be in effect, such an offender could be prosecuted in the 
federal courts. 


CHAPTER XV 

COMPARATIVE STATEMENT ANALYSIS 

Practical Value 

The analysis of a merchant’s financial affairs along the 
lines indicated in the preceding chapters gives the credit man 
a clear insight into the condition of the business at the time 
the statement was prepared, and when these analyses are com¬ 
pared year with year over an extended period, still further 
information is disclosed. This means that we should have 
some record, as between property statements of different dates, 
so as to be able to compare accurately and quickly the essential 
items shown on such statements. It is for this reason that 
efficient credit departments call for statements from their 
customers at frequent intervals, for the value of such compara¬ 
tive credit data in determining the trend of the business and to 
show whether it is improving, standing still, or retrograding, 
cannot be overestimated. 

On the other hand, it is equally true that when analyzed 
only superficially, comparative statements may be very deceptive 
and misleading, and it is only when the analysis is properly 
carried out that they afford the very best source of informa¬ 
tion or index as to the trend of the business. 

Use of Comparative Statements 

In comparative analysis an increase in the net worth as 
between any two years creates a feeling of security in the mind 
of the credit man, but in comparing financial statements it is 
necessary to note not only the change in net worth, but also 
the change in the specific items, because it is entirely possible 
for the net worth to show a steady increase without necessarily 


179 


180 SAFEGUARDING PAYMENT IN SALE OF GOODS 


signifying a betterment in the concern’s financial condition, 
from the point of view of the credit man; i.e., the increment 
may be due entirely to an increase in value of the fixed assets. 
The point can be made clear by means of a simple illus- 


tration: 




Quick Assets. . . 
Fixed Assets.... 

1921 

. $30,000.00 Quick Liabilities. .. . 

. 15,000.00 Fixed Liabilities. . . . 

... $15,000.00 
8,000.00 


$45,000.00 
Working Capital. 
Net Worth. 

. $15,000.00 

. 22,000.00 

$23,000.00 

Quick Assets. . . 
Fixed Assets.... 

1922 

. $25,000.00 Quick Liabilities. .. . 

. 30,000.00 Fixed Liabilities. . . . 

... $15,000.00 
8,000.00 


$55,000.00 
Working Capital. 
Net Worth. 

. $10,000.00 

. 32,000.00 

$23,000.00 


The net worth is larger in 1922 by $10,000 but the 
business is in a worse condition in so far as the extension of 
credit is concerned, because of the decrease in working capital. 


Proper Index 

As a rule if the business is improving, the the ratio between 
the quick assets and the quick liabilities should show an 
increase; and conversely, if the ratio is decreasing (even though 
the actual amount of the quick assets over the quick liabilities 
is increasing) the credit situation is becoming weaker. 

To simplify the illustration of this point, let us first assume 
that there are no fixed assets or fixed liabilities to be taken 
into consideration in connection with the following statements: 


December 31, 1920 
3 b 1921 
31, 1922 


Surplus of 

<< a 

a n 


200 over liabilities of 

<( <4 44 

400 

1,000 “ 


$ 200 
600 
9,000 


1920 Statement 

Quick Assets. $400.00 Quick Liabilities. 

Excess of quick assets over quick liabilities = $200 

Ratio =2 : 1 


$200.00 




















COMPARATIVE STATEMENT ANALYSIS 


181 


1921 Statement 

Quick Assets. $1,000.00 Quick Liabilities. $ 600.00 

Excess of quick assets over quick liabilities = $400 

Ratio = 5:3 

1922 Statement 

Quick Assets. $10,000.00 Quick Liabilities. $9,000.00 

Excess of quick assets over quick liabilities = $1,000 

Ratio = 10 :9 

In order to test the “credit strength” of the business during 
these three years respectively, let us further assume the business 
to be a partnership and that one of the partners dies, necessitat¬ 
ing a dissolution of the partnership and a sacrifice of the assets 
on a declining market, which nets but 50 per cent of the listed 
valuation: 

In 1920 there will be $200 to pay liabilities amounting to $200 

“ 1921 “ “ “ 500 “ “ “ “ “ 600 

“ 1922 “ “ “ 5,000 “ “ “ “ “ 9,000 

In other words, if your account with the partnership 

amounted to $100 at the time of the dissolution, you would 
recover the full amount in 1920. In 1921 your loss would 
amount to $40, and in 1922 you would receive but $10 and 
suffer a loss of $90. 

The conclusion to be drawn from this illustration is that 
where the excess of quick assets over quick liabilities is larger 
but the ratio between them is smaller, the credit strength of the 
business, or the extent to which the line of credit extended is 
protected, is weakened. 

This does not necessarily mean that under such circum¬ 
stances the credit capacity of the business, or the amount of the 
working capital, is not greater; or that this partnership would 
not be entitled to a larger line of credit in 1921 than in 1920, 
or in 1922 than in 1921 ; but what it does mean is that the 
credit extended would not be so well protected or secured. In 
other words, while the credit capacity of the business would be 
greater, the credit strength would be weaker. 






182 safeguarding payment in sale of goods 


So the vital issue in comparing financial statements covering 
different years of business is to find out whether the relation 
or ratio between the quick assets and quick liabilities has 
increased or diminished. This comparison should be made each 
year so that fluctuations in the ratio can measure the degree 
of increase or decrease in the strength of the risk. 

Compilation of the Statement 

As a matter of office routine, the preliminary compilation 
of the record in comparative form can very readily be prepared 
by some subordinate in the department, thereby saving the time 
of the credit executive. The common practice in preparing 
a comparative statement for analysis is to use some standard 
form in which the succeeding statements may be set off, one 
against the other, in such a way as clearly to indicate the 
variations. 

The form of comparative statement shown in Form 9, 
taken from Alexander Wall’s “Analytical Credits,” is well 
designed to carry out the method which has just been 
described. 

Relation of Net Income to Capital Stock 

While the net worth is misleading when used as an index 
in the analysis of non-corporate reports, there is a correspond¬ 
ing index that is frequently used in the analysis of corporate 
statements which is equally misleading and fallacious unless 
one understands precisely what it represents and is aware of 
the danger involved when it is improperly applied. 

Perhaps the most commonly used index as to the progress 
a corporation is making in the conduct of the business is the 
ratio existing between the net income and the capital stock, and 
while reliable inferences may be made under certain conditions 
from the fluctuations in this ratio, it is misleading when used 
as an index unless one understands precisely what it represents 
and the purpose for which it may be properly used. 


COMPARATIVE STATEMENT ANALYSIS 

COMPARISON OF STATEMENTS 



ASSETS 






Cash on Hand and in Bank, 

Bills Receivable, all good, on hand, 

Bills and Acc’ts Rec. due from OfT’rs or St’kholders, 
Accounts Receivable, all good, due from customers. 
Merchandise, finished, 

Merchandise, unfinished. 

Raw Material, 

TOTAL QUICK ASSETS 

Real Estate, 

Buildings, 

Machinery and Tools, 

Furniture and Fixtures, 

Prepaid Insurance, 

TOTAL NON-CURRENT ASSETS, 

TOTAL, 

LIABILITIES 

Bills Payable for Merchandise, 

Bills Payable negotiated to Banks, 

Bills Payable otherwise disposed of, 

Bills and Acc’ts Pay. due Off’rs or Stockholders, 
Open Accounts, not due, 

Open Accounts, past due. 

Deposits of Money, 

Interest Accrued, 

Pay Roll and Salaries Accrued, 

Reserved for Taxes, 

TOTAL QUICK LIABILITIES, 
Liens or Mortgages on Real Estate, 

Bonded Debt, 

TOTAL LIABILITIES, 

Reserves, 

Capital, 

Surplus, including undivided profits, 

Net Worth, 

TOTAL, 

Total Quick Assets, 

Total Quick Liabilities, 

Excess Quick, 

Deduct Reserves Against Current Assets, 

Net Excess Quick, 

Ratio, 

Sales, 

Net Profits Last Year’s Business, 

Dividends or Withdrawals, 

Insurance on Merchandise, 

Insurance on Real Estate, 

Contingent Liability, 

Outside Worth of Sureties, 







Form 9. Comparative Statement 
























184 safeguarding payment in sale of goods 


Improper Use 

Several years ago, in order to point out the fallacy involved 
in a statement which was being given wide publicity, to the 
effect that the four largest packing companies were earning 
over 25 per cent on their capitalization, a very interesting and 
enlightening analysis of the situation was made with a view 
to showing how misleading, although true, the statement actu¬ 
ally was. 

As a first step the analyst tabulated the capital stock, sur¬ 
plus, reserves, bonded debt, and current liabilities of each 
of the four companies, in order to show the great variance that 
existed in the manner and means of financing these corpo¬ 
rations. The findings are shown on page 185. 

From this table it will be noted that, whereas Armour and 
Morris financed their business principally through the issue of 
bonds, the principal source of capital used in the business of 
Cudahy and Swift was derived from the sale of stock. 

As a second step in the analysis, the ratio of the net income 
to the capital stock in each of these companies was calculated, 
showing that whereas the total earnings of all four com¬ 
panies averaged 25 per cent of the capital stock, it was con¬ 
siderably less than that in the case of the two companies which 
had comparatively large bond issues outstanding, namely, 
Armour and Morris. The percentage for each of the com¬ 
panies was as follows: 

Armour Cudahy Morris Swift 
& Co. Pkg. Co. & Co. & Co. 

Ratio of net income to capital stock. 55.0 6.03 77.3 18.8 

Average for all 4 companies = 25.65% 

(When the financial writer made his calculation he added the earnings 
of all the companies together and divided by the aggregate of the actual 
issues.) 

Ratio of Net Income to Total Invested Assets 

Having thus demonstrated how fallacious and misleading 
the general statement referred to actually was, the next step 



COMPARATIVE STATEMENT ANALYSIS 


185 







































186 SAFEGUARDING PAYMENT IN SALE OF GOODS 

was to establish the proper basis for estimating or measuring 
business earnings. This he did, by calling attention to the fact 
that the capital stock of a corporation alone does not represent 
the total invested assets of a business, and that the total capital 
fund employed in the business must be used as the basis for 
computing the percentage return of the business. In other 
words, capital, as distinguished from capital stock, consists 
of all the property owned by the corporation, without regard 
to whether it was contributed by the stockholders or not. 1 

In the case of these four companies, when the ratio of net 
income to the total invested assets was used as the basis of 
comparison, it showed the following: 

Armour Cudahy Morris Swift 
& Co. Pkg. Co. & Co. & Co. 

Ratio of net income to total assets. 5-46 1.86 3-94 6.83 

Average for all 4 companies = 5.57% 

Internal Analysis—Other Ratios 

In the preceding sections the more or less general method of 
comparative statement analysis was discussed, which consists in 
putting into comparative relationship the current assets and 
liabilities of successive years. But the tendency of this kind 
of analysis has been to stimulate comparisons in bulk rather 
than comparisons of proportions, and it has been contended 
that reliance upon such ratios alone is unscientific. 

However, the fact that such a proportional study method 
is vindicated by the extent to which the current ratio has been 
adopted gives rise to the probability of other proportional 
comparisons being also of value, and it was with this thought 
in mind that Alexander Wall, in his treatise on “Analytical 
Credits,” has made a most interesting and comprehensive 
analysis of numerous other ratios, which are as follows: 

1. Ratio of Receivables to Merchandise. 

This ratio is found by adding the accounts and bills 


1 See Greendlinger, Financial Statements, p. 226. 




COMPARATIVE STATEMENT ANALYSIS 187 

receivable and dividing by the total of the merchandise 
inventory. 

2. Ratio of Debt to Net Worth. 

This ratio is found by dividing the total debt, both 
current and funded, by the total net worth. 

3. Ratio of Net Worth to Non-Current Assets. 

This ratio is found by dividing the net worth by the 
total of the non-current or fixed assets. 

4. Ratio of Sales to Receivables. 

This ratio is found by dividing the total sales by the 
total receivables. 

5. Ratio of Sales to Merchandise. 

This ratio is found by dividing the total sales by the 
merchandise inventory. 

6. Ratio of Sales to Net Worth. 

This ratio is found by dividing the total sales by the 
net worth. 

7. Ratio of Sales to Non-Current Assets. 

This ratio is found by dividing the total sales by the 
non-current assets. 

Window Dressing 

Mr. Wall properly calls attention to the fact that the real 
fundamental value of a study of the current ratio lies not so 
much in the development of the percentage at which the cur¬ 
rent ratio rests as in a study of the direction in which the cur¬ 
rent ratio is moving. By this he simply means that an increas¬ 
ing current ratio may normally be expected to accompany an 
improving condition, and that a receding current ratio may 
normally be expected to accompany a weakening credit con¬ 
dition. 

One argument in favor of resorting to other comparisons 
in the analysis of the statement is the fact that the knowledge 
on the part of credit-seekers that their statements are to be 
tested by the current ratio has led to the “doctoring” of state¬ 
ments. This is not difficult and can be successfully accom- 


188 SAFEGUARDING PAYMENT IN SALE OF GOODS 


plished by any one of several processes. For illustration, sup¬ 
pose a statement shows the actual status of the business to 
be as follows: 

Current Assets. $1,500 Current Liabilities. $1,000 

Ration i l / 2 : 1 

The merchant, realizing that this ratio will not satisfy the 
required standard of 2 to 1, proceeds to liquidate some of his 
current assets, either by forcing a sale of part of his mer¬ 
chandise, or possibly by forcing payment of part of his re¬ 
ceivables, and with the proceeds thus obtained reduces his cur¬ 
rent liabilities. Let us assume that he succeeds in liquidating 
his current assets $500. His statement would then read as 
follows: 

Current Assets. $1,000 Current Liabilities. $500 

Ratio = 2 : 1 

The explanation of this change in the ratio lies in the fact 
that an addition of an equal amount to both the current assets 
and the current liabilities has the effect of changing the pro¬ 
portional relation, or ratio. In other words, an increase of 
both the current assets and current liabilities can only keep the 
ratio at the same point if it is in the same proportion as ex¬ 
pressed by the ratio. This process of doctoring is commonly 
referred to as “window dressing.” 

Other Ratios Explained 

The other ratios developed by Mr. Wall tend to disclose 
the proportions existing between actual component parts of the 
statement, the theory being that the fluctuation of these items 
and their proportions to each other afford an index as to the 
actual condition of the business. Following is an explanation 
of these ratios: 

1. Ratio of Receivables to Merchandise. It has be¬ 
come proper practice to show merchandise on statements either 
at cost or at present market value if the present market value 






Comparative statement analysis 189 

has fallen below the cost price, in order that no anticipatory 
profit shall appear in this item. 

The item of receivables, however, represents the cost of 
the merchandise plus the profit to be derived from the sale. 

Therefore, according to Mr. Wall, if we have a statement 
primarily merchandise as to its current assets, and later a 
statement primarily receivables as to its current assets, the 
change ought to be accompanied by a rise in the current ratio. 
If this is not the case, then the management of the business 
has added something in the nature of current debt which 
should be investigated with a view to determining just why 
such negative operation was necessary. 

2. Debt to Net Worth. Ordinarily, the economic capi¬ 
tal used in a business is derived from two sources : (1) the 

portion advanced by the owners, and (2) the portion advanced 
by the creditors. Once intermingled, an exact division of the 
assets purchased by each becomes practically impossible; but 
it is possible at any time to ascertain the proportion that exists 
between the owned and the borrowed capital. If, for example, 
the total debt of the business is equivalent to the net worth, it 
follows that 50 per cent of the assets are secured from funds 
belonging to the creditors. 

Quick Assets. $ 600 Quick Liabilities. $300 

Fixed Assets. 600 Fixed Liabilities. 300 


$1,200 Total Debt. $600 

Net Worth. $600 

The inference to be drawn from fluctuations in this ratio 
is that if in successive years the percentage of debt to the net 
worth is found to be increasing, the business is relying to a 
greater and greater extent for its economic capital upon the 
good-will of its creditors. As the debt ratio rises, the moral 
risk becomes more important, because any loss of faith in the 
future of the business would affect a larger part of the capi¬ 
tal used in the business. 










safeguarding payment in sale of goods 


190 

When a large ratio of debt to net worth is shown, but a 
considerable portion of the debt is funded, it is advisable to 
establish a current debt to net worth ratio to see if this ratio 
is reasonably low. For example, if a 50 per cent ratio of debt 
to net worth seems reasonable and the statement discloses a 
75 per cent ratio, the ratio of current debt to net worth should 
be less than 50 per cent, because when a proportion of the debt 
is funded, the necessity for current indebtedness is thereby 
materially reduced. Under such circumstances, it is the opin¬ 
ion of Mr. Wall, a safe current debt to net worth ratio ought 
not to exceed approximately 30 per cent, and approximately 45 
per cent of the total debt to net worth should be in funded debt. 

3. Net Worth to Non-Current Assets. It is not, as 
a rule, considered good business judgment to have non-current 
assets represented by that part of the whole capital which has 
been supplied by the creditors, except as may be provided under 
certain circumstances by funded debt. 

By establishing a proportional comparison between the net 
worth and non-current assets, it is possible to determine what 
proportion of the owner-controlled funds or capital remains 
available, after the non-current assets have been financed, for 
the current operating features of the business. 2 

If it is found that there has been an increase in net worth 
but that the ratio of net worth to non-current assets has de¬ 
clined, the logical inference would be that the owners of the 
business have expanded their plant more rapidly than is justi¬ 
fied by the normal growth of the business. It is not difficult 
to fancy the embarrassment which might ensue from such a 
condition in a period of business depression. 

4. Sales to Receivables. Assuming that the 2 to 1 
current ratio standard is being used, there is little doubt but 
that any creditor would be willing to extend or continue a line 
of credit in spite of a lower current ratio if he could be as- 


2 Under the Federal Reserve Act only such paper is eligible for rediscount as has been 
used to produce funds for commercial purposes. 



COMPARATIVE STATEMENT ANALYSIS 


191 

surecl as to the “freshness” of the receivables. The question 
then develops as to how the character of the receivables may 
be analyzed with reasonable certainty. 

If a series of successive statements discloses that the bulk 
of the receivables is increasing, but that the volume of sales 
is also increasing with sufficient rapidity to increase the ratio 
of sales to receivables, it can reasonably be inferred that the 
business is not accumulating old receivables. If, however, an 
increasing volume of sales but a decreasing ratio as between 
the sales and receivables is found, the inference is that there 
is a greater proportion of the receivables past due. In other 
words, the liquidity of the receivables can be measured by keep¬ 
ing a record from year to year of the ratio that exists between 
the sales and the receivables. 

5. Sales to Merchandise. If the comparison of state¬ 
ments from year to year discloses an increasing inventory, it 
should tend to suggest that the business may be working into 
an overinventoried condition. But if a further analysis dis¬ 
closes that the volume of sales is also increasing in sufficient 
amount to increase the ratio of sales to merchandise, this fact 
would serve to rebut any such presumption, because the inven¬ 
tory, while larger, is being consumed more rapidly. 

6. Sales to Net Worth. True business efficiency is 
predicated upon the activity of the invested capital and this 
can be measured to a very great extent by the relationship of 
the sales to the net worth. In other words, assuming a fixed 
margin of profit, the greater the volume of sales, the greater 
will be the profits on a fixed capital or net worth investment. 
Consequently, if a ratio of sales to net worth is established, the 
activity of the owner’s invested capital can be ascertained. If 
this ratio is an increasing ratio, the activity of these funds is 
greater, and with the same margin of profit, the earnings 
should be greater. 

As Mr. Wall states, an old-established business lacking 
progressive management may not keep its funds actively em- 


192 SAFEGUARDING PAYMENT IN SALE OF GOODS 

ployed. This inactivity may be sufficient to run the business 
into what has been termed a condition of “dry rot.” This 
condition is often indicated by a continual yearly falling off 
in the ratio that exists between the sales and the net worth. 

7. Sales to Non-Current Assets. The purpose of 
establishing this ratio is to determine whether or not the pro¬ 
ductivity of the fixed assets is increasing or decreasing, and 
if such a relationship is established and then reduced to a per¬ 
centage basis by multiplying the resultant by 100, it affords an 
index showing the dollars of sales for every dollar invested 
in non-current assets. 

The following comparative statement is taken to show the 
extent to which the intrinsic value of an apparently good risk 
may be modified by changes during the two preceding years: 



Assets 

1920 

1921 

1922 

Capital Assets: 

Land and Buildings. 

.. $ 75,000.00 

$ 75,000.00 

$ 75,000.00 

Machinery and Equipment. . 

22,540.00 

22,640.00 

24,110.00 

Furniture and Fixtures. 

6,425.00 

6,655.00 

7,196.00 

Total. 

.. $103,965.00 

$104,295.00 

$106,306.00 

Current Assets: 

Merchandise. 

.. $ 42,226.16 

$ 49,869.42 

$ 48,646.62 

Cash. 

19,212.73 

11,164.13 

6,162.50 

Accounts Receivable. 

21,323.14 

28,266.62 

24,121.06 

Notes Receivable. 

8,429.22 

7,010.71 

7,071.13 

Total. 

.. $ 91,191.25 

$ 96,310.88 

$ 86,001.31 

Total Assets. 

.. $195,156.25 

$200,605.88 

$192,307.31 


Liabilities 



Capital Liabilities: 

Capital Stock. 


$ 85,000.00 

$ 85,000.00 

Mortgage on Plant. 


40,000.00 

40,000.00 

Total. 


$125,000.00 

$125,000.00 

Current Liabilities: 

Accounts Payable. 

■ •• $ 7.103.15 

$ 13,264.24 

$ 18,002.65 

Notes Payable. 

6,000.00 

16,500.00 

18,500.00 

Total. 

•• $ 13,103-15 

$ 29,764.24 

$ 36,502.65 
















































COMPARATIVE STATEMENT ANALYSIS 


193 


Liabilities 


Reserves: 

1920 

1921 

1922 

Depreciation of Buildings. . . 

. .. $ 9,160.00 

$ 11,748.00 

$ 12,486.00 

Depreciation of Equipment. 

7,323.00 

8,781.00 

10,052.00 

Depreciation of Fixtures. . . , 

1,451.00 

1,610.00 

2,228.00 

Total. 

. .. $ 17,934.00 

$ 22,139.00 

$ 24,766.00 

Surplus. 

. .. $ 39 , 119 -10 

$ 23,702.64 

$ 6,058.66 

Total Liabilities. 

. . . $195,156.25 

$200,605.88 

$ 192 , 357.31 

Total Quick Assets. 

... $ 91,191.25 

$ 96,310.88 

$ 86,001.31 

Total Quick Liabilities. 

13,103.15 

29,764.24 

36,502.65 

Working Capital. 

... $ 78,088.10 

$ 66,546.64 

$ 49,498.66 

Ratio. 

7 to 1 

3 to 1 

2 to 1 

Sales. 

... $140,165.36 

$112,925.75 

$105,544.04 


This statement indicates a fairly strong financial condition 
in 1922, showing working capital amounting to $49,498.66, 
and a current ratio of a little better than 2 to 1. In other 
words, the company, in the absence of any other adverse in¬ 
formation, would be entitled to a reasonable line of credit. 
But at the same time, when viewed in comparison with the 
statements of the preceding two years, it discloses a rather un¬ 
satisfactory condition, in view of the rapidly decreasing cur¬ 
rent ratio and the surplus account. 

Furthermore, whereas the volume of sales amounted to 
some $35,000 less in 1922 than in 1920, the amount of the 
receivables, instead of showing a corresponding decrease, show 
an increase of approximately $15,000. 






























CHAPTER XVI 

SIGNIFICANCE OF WORKING CAPITAL 


Science of Working Capital 

No business handicapped by a shortage of working capital 
can function as efficiently as one with a sufficient working capi¬ 
tal at its disposal. There are times when a merchant can get 
along with a very limited amount of working capital in his 
business, and others when he needs three or four times as much 
to handle the same relative amount of business, or perhaps 
an even smaller volume of business. During periods of busi¬ 
ness prosperity when business is booming, so to speak, it re¬ 
quires no special ability on the part of the average merchant to 
do a good volume of business, owing largely to the favorable 
conditions that exist for financing his business. For example, 
if he is doing at such a time a volume of business that would 
require a working capital of $75,000, he probably could bor¬ 
row $60,000 from the bank on the strength of it without any 
trouble, and with small risk of being called upon to repay it 
at a time when it would not be convenient or possible without 
suffering a loss. 

If, however, instead of being able to convert his goods into 
money rapidly, he is confronted with the opposite situation, 
where the goods are accumulating and his volume of business 
has for some reason contracted, the amount of working capital 
that he needs is greater than before and his ability to get it is 
correspondingly reduced, owing to the less favorable capital 
conditions that exist at such times. 

It has been truthfully said that the failure of merchants to 
understand the science of working capital in their business 
under different business conditions constitutes one of the prin- 

194 


SIGNIFICANCE OF WORKING CAPITAL 195 

cipal reasons for business failures. And it is also true that the 
failure on the part of the credit man of a business to under¬ 
stand the science of working capital under different kinds of 
business conditions has resulted in serious losses which might 
otherwise have been avoided. 

The Business Cycle 

Business conditions are never constant and commerce is 
constantly vacillating between alternate periods of dullness and 
of prosperity, or, as we shall hereafter refer to them, “liquida¬ 
tion periods” and “buying movements.” This is what is meant 
when it is said that business moves in well-defined cycles, each 
of which consists of two parts or phases, a buying period and 
a liquidation period. In other words, periods of business pros¬ 
perity are invariably followed by periods of business depres¬ 
sion, and vice versa. Numerous reasons and causes are given 
for this, but perhaps the most important is the maladjustment 
of production to the changed relation of supply and demand, 
and the exhaustion of available credit. 

During a liquidation period a very important consideration 
in connection with the factor of working capital is keeping 
the working capital in as liquid a form as possible. The reasons 
for this are quite obvious. If the working capital is kept very 
liquid it is available for debt-paying as obligations fall due. 
Furthermore, it does not depreciate in value much, if at all. 
Whereas if it is being carried in the form of merchandise and 
the value of the merchandise declines, it does depreciate. 

Credit Phase 

However, it is the credit phase of this economic transi¬ 
tion that is of importance to the credit man; in other words, 
in what way and to what extent does this change from buying 
periods into periods of liquidation affect the credit capacity or 
debt-paying power of his customers? In the first place, high 
commodity prices must go hand in hand during the up scale 


196 SAFEGUARDING PAYMENT IN SALE OF GOODS 

or buying movement of the cycle, with a decrease of business 
failures. The reason is plain enough. As prices and values 
of commoditites advance, merchants are prosperous, their in¬ 
vestments of capital increase in value, and their profits in¬ 
crease—they make money. Consequently, the rate of busi¬ 
ness mortality declines. 

On the other hand, just as that credit-strengthening move¬ 
ment is true and characteristic of the up scale or buying period 
of the cycle, so it is equally true that during the liquidation 
period of the cycle, as commodity prices become deflated, the 
number of business failures increases. Consequently, the re¬ 
sponsibility involved in handling the credit risks in connection 
with the sales end of a business during a liquidation or de¬ 
flationary period constitutes a very important part of a credit 
man’s work. He is practically free from anxiety during the 
up scale of such a general cycle, but he is confronted with a 
serious problem during the down scale. 

Proper Handling of Working Capital 

It is not difficult to illustrate the importance of the cash 
capital factor in a business during a liquidation period. It 
can be done by means of two simple illustrations, showing the 
natural trend in the changes that take place in the assets con¬ 
stituting the working capital of a business during a liquidation 
period, first, in the business of a merchant who does not under¬ 
stand the science of working capital, and therefore does not 
properly prepare for the liquidation period, and then in the 
business of another merchant doing business under precisely 
the same conditions, but who does understand the natural 
changes that take place during a liquidation period, and makes 
the necessary preparations to “weather the storm” without 
incurring any unnecessary and avoidable losses. 

Both of these illustrations start with the financial status of a 
business at the end of a period of business prosperity and at a 
time when orders were being received in heavy volume and 


SIGNIFICANCE OF WORKING CAPITAL 


197 


the production facilities were being taxed to the utmost to 
satisfy the existing demand for the product. The fixed asset 
items have not been included for the reason that they undergo 
comparatively little change in value or depreciation during the 
revolution of the business cycle. 

Let us assume that the first merchant, having increased his 
volume of business considerably, has determined to maintain 
that volume as his future standard regardless of changes in 
general business conditions, and that, instead of regulating 
his volume of production to meet the changing demand for his 
goods, he regulates the demand for his product through the 
sale price of his goods. His current assets, cost of produc¬ 
tion, and new orders, or new business at the beginning of a 
6 months’ period and at the end of each of the 6 months were 
as follows: 


End of End of End of* End of End of End of 

1st Mo. 2nd Mo. 3rd Mo. 4th Mo. 5th Mo. 6th Mo. 


Merchandise: 

Finished Goods. $13,000 

Goods in Process... 7 .500 

Raw Materials. 10,000 

Accounts Receivable. . 9,000 

Notes Receivable. 3,500 

Cash. 7,000 


Quick Assets. $50,000 


Cost of Production.... $15,000 
New Orders. 15,000 


Increase of Stock 


$15,000 $18,000 $22,000 

7.500 7,5oo 7,000 

9.500 9,500 9,000 

9,000 8,500 7,500 

3,000 2,500 2,000 

6,000 4,000 2,500 


$50,000 $50,000 $50,000 


$15,000 $15,000 $13,000 

13,000 12,000 9,000 


$ 2,000 $ 3,000 $ 4,000 


$26,000 $30,000 $32,000 

6,000 5,000 4,000 

8,000 7,500 7,000 

7,000 6,000 5,500 

1,500 1,000 500 

1,500 500 . 


$50,000 $50,000 $50,000 


$12,000 $xi,ooo $ 8,000 
8,000 7,000 6,000 


$4,000 $ 4,000 $ 2,000 


Buying inactivity on the part of the consuming public is 
one of the characteristic features of a depressed business condi¬ 
tion, and there are times when even radical price reductions do 
not suffice to stimulate buying. So it has been assumed that in 
spite of all the efforts made by the merchant to maintain his 
chosen volume of business, the new orders decline in volume 
month by month from $15,000 the first month to $6,000 at the 


































igS SAFEGUARDING PAYMENT IN SALE OF GOODS 

end of the 6 months’ period, which is not a greatly exaggerated 
change in volume during extreme liquidation periods. 

During the first month the merchant was able to keep his 
production running at the rate of $15,000 a month, although 
there was a decline in the volume of new orders from $15,000 
to $13,000, or of $2,000, which was added to the completed 
stock. This $2,000, which was converted into finished goods 
during the month, increased the completed stock on hand from 
$13,000 to $15,000. The amount of working capital in the 
business remaining constant, this means that a reduction of 
$2,000 must be made in the other quick assets, and it has been 
assumed that in addition to the $500 converted raw material 
which was not supplanted, $500 of the notes receivable and 
$1,000 of the cash on hand was used. In other words, the 
$2,000, comprising $1,000 cash, $500 notes receivable, and 
$500 raw material, was converted into finished stock on hand 
during the first month of this liquidation period. 

In the second month, the new business fell off another 
$1,000, whereas the production cost of $15,000 was still main¬ 
tained, and it will be noted that the finished goods on hand 
increased from $15,000 to $18,000. Of this $3,000, $1,000, it 
will be assumed, was drawn from the accounts and notes 
receivable, and the remaining $2,000 from the available cash. 

At the end of the third month we find that the new business 
has dropped off $3,000, and in view of the rapidly accumulat¬ 
ing stock on hand, which now amounted to $22,000, it is 
assumed that the production costs were curtailed $2,000. It 
will be noted that the additional $4,000 worth of finished 
goods resulted in a further reduction being made in the other 
assets, which reduction is assumed to have comprised $500 
of goods in process, $500 of raw materials, $1,000 of accounts 
receivable, $500 of notes receivable, and $1,500 of cash. 

By the end of the fourth month it was absolutely neces¬ 
sary to curtail further the production cost $1,000 and the 
volume of orders received diminished from $9,000 to $8,000, 


SIGNIFICANCE OF WORKING CAPITAL 


199 


necessitating the carrying in stock of an additional $4,000 
worth of finished goods, which, it is assumed, was taken out 
of the other assets as follows: goods in process $1,000, raw 
materials $1,000, accounts receivable $500, notes receivable 
$500, and cash $1,000. 

Gradually we find the merchant’s credit position becoming 
weaker and weaker in spite of the increased curtailment in the 
cost of production, until at the end of the fifth month of this 
liquidation period the finished goods was more than doubled 
in amount and the cash capital was reduced from $7,000 to 
$500. 

By the end of the sixth month (liquidation periods some¬ 
times last from 12 to 18 months) the merchant would be com¬ 
pelled to discontinue business (assuming he lasted that long) 
unless he was in a position to obtain additional funds from 
outside sources with which to continue the business. 

So we find that instead of successfully carrying out his 
intention to maintain a uniform cost of production of $15,000 
a month he was not only compelled to cut it in half within 
6 months’ time, but that by that time his financial strength 
had diminished to such an extent as to compel him to discon¬ 
tinue business. The business was no longer able to maintain its 
organization, simply because the merchant did not understand 
the science of working capital in the conduct of his business. 

His conclusion that a working capital of $50,000 was 
sufficient to finance a business of $15,000 a month at all 
times, regardless of changing business conditions, was unsound. 
It was sufficient, and no doubt more than sufficient, to finance 
his business during the preceding buying movement, because 
a business does not require much cash capital at such times. 
The tendency then is for the stock on hand to diminish rather 
than increase. So then it becomes obvious that the cause of 
the merchant’s downfall was his failure to realize the economic 
fact that more working capital is required in a business at 
one time than at another. 


200 


SAFEGUARDING PAYMENT IN SALE OF GOODS 


Improper Handling of Working Capital 

In the second illustration we will assume that the merchant, 
operating under precisely similar business conditions as in the 
first, is one who does understand the science of working capital, 
and see what preparation may be made and precautions taken 
to avoid the incurrence of such unnecessary losses. By “similar 
business conditions” is meant that the same volume of orders 
was received and the accounts and notes receivable were being 
realized upon from month to month at the same rate. 

But instead of trying to adhere to and carry out some 
predetermined plan whereby the cost of production was to 
remain fixed at some arbitrary figure, it is assumed that this 
second merchant realizes the necessity of curtailing his produc¬ 
tion at the very beginning of a liquidation period. Of course, 
his sole object is so to manage his finances as to be, if possible, 
in a stronger instead of weaker position financially at the end of 
the liquidation period, and thus in a better position to take 
advantage of the increased volume of business offered when 
the next buying movement sets in. His quick assets, cost of 
production, and new orders change over the six months’ period, 
as follows: 


End of End of End of End of End of End of 
Start ist Mo. 2nd Mo. 3rd Mo. 4th Mo. 5th Mo. 6th Mo. 


Merchandise: 

Finished Goods. $13,000 

Goods in Process. . . 7,500 

Raw Materials. 10,000 

Accounts Receivable. . 9,000 

Notes Receivable. 3. soo 

Cash. 7,000 


Quick Assets. $50,000 


Cost of Production.... $15,000 
New Orders. 15,000 


Increase of Stock 


$13,000 

$14,000 

$16,000 

7,000 

7,000 

6,000 

9,000 

8,500 

8,000 

9,000 

8,500 

7,500 

3.500 

2,500 

2,000 

8,500 

9,500 

10,500 

$50,000 

$50,000 

$50,000 

$13,000 

$13,000 

$11,000 

13,000 

12,000 

9,000 


$ 1,000 

$ 2,000 


$18,000 

$20,000 

$23,000 

5,000 

5,000 

4.500 

7,500 

7,000 

6,500 

7,000 

6,500 

5,500 

1,500 

1,000 

500 

11,000 

10,500 

10,000 

$50,000 

$50,000 

$50,000 

$10,000 

$ 9,000 

$ 9,000 

8,000 

7,000 

6,000 

$ 2,000 

$ 2,000 

$ 3,000 




































SIGNIFICANCE OF WORKING CAPITAL 


201 


During the first month it will be noted that the merchant 
decreased his production from $15,000 to $13,000, which, it so 
happened, was just sufficient to offset the decline in new busi¬ 
ness received. The effect of this decrease in production on the 
assets, it is assumed, was to decrease the amount of goods in 
process and the raw materials (the tendency under such circum¬ 
stances would be to exhaust the supply on hand) to the extent 
of $1,500, which was added to the cash on hand. 

In the second month the same cost of production was main¬ 
tained, whereas the new business fell off another $1,000. It 
will be noted that as a result of this the finished goods increased 
in amount from $13,000 to $14,000, which was offset by the 
$500 reduction in raw materials item and an equivalent reduc¬ 
tion in the accounts receivable. The notes receivable were also 
reduced $1,000 which, as a matter of course, increased the cash 
on hand from $8,500 to $9,500. 

At the end of the third month we find that in spite of the 
fact that the merchant made a further reduction in his cost 
of production from $13,000 to $11,000, the overproduction 
for the month amounted to $2,000, due to the sharp decrease of 
$3,000 in the volume of new business received. This $2,000 
overproduction increased the finished goods from $14,000 
to $16,000, but owing to a further reduction being made in the 
outstandings, it will be noted that his cash capital increased 
another $1,000. 

By the end of the fourth month he had curtailed his produc¬ 
tion another $1,000, and the volume of orders received also 
diminished $1,000, increasing the amount of his finished goods 
from $16,000 to $18,000. 

And so on until after the merchant has passed through 
another two months of similar readjustment, we find 
his credit position becoming stronger and stronger irrespective 
of the decided falling off in his volume of business from 
$15,000 to $6,000 a month. 

The important point to be noted in this connection is that 


2021 safeguarding payment in sale of goods 


regardless of the steady decrease made by the merchant in his 
production, it was insufficient to offset the constant decline 
in new business received, as a consequence of which the amount 
of his finished goods was steadily increasing, until at the end 
of the 6 months’ period he had accumulated some $23,000 fin¬ 
ished stock on hand ready to throw on the market just as soon 
as the buying movement set in. However, as a result of cur¬ 
tailing his production he was able to increase his available cash 
from $7,000 to $10,000, thereby placing himself in a relatively 
stronger financial condition at the end of the 6 months than 
he was at the beginning. 

With proper records and information before him, the effi¬ 
cient credit man should be able to determine where the respon¬ 
sibility for the financial condition of a business rests. Here, 
as we have seen, we have two merchants doing the same volume 
of business under precisely the same business conditions; but 
whereas one merchant was forced into a hopelessly inefficient 
condition by the end of the 6 months’ period of liquidation, 
another merchant actually succeeded in increasing his cash 
capital from $7,000 to $10,000, and consequently was in a 
stronger financial condition at the end of the same 6 months’ 
period. 

The significance of this to a credit man is that such simple 
yet enlightening illustrations serve to indicate how important it 
is to scrutinize closely this very vital factor of working capital 
in a business, and particularly in analyzing financial statements 
on the eve of periods of business depression. 


PART IV 


INCIDENTAL FACTORS AFFECTING A 
CONCERN’S CREDIT STANDING 








CHAPTER XVII 

MANNER OF PAYMENT 

Relation between Payments and Profits 

Once an account is opened, other influences are brought to 
bear on a customer’s credit standing which are of an entirely 
different nature from those which originally determined his 
financial or credit responsibility. For at first it is presumed 
that the applicant is deserving of a credit line of so much, and 
then it lies with him to prove himself worthy of it by strictly 
observing the terms of payment. 

To obtain some conception of the significance which the 
manner of payment has on a concern’s credit standing, and also 
of the importance of it in the successful management of a 
business, let us first consider the relation that exists between 
payments and profits. 

It is a common if not the usual custom for merchants 
simply to deduct the purchase price or selling cost of a com¬ 
modity from the sale price in order to measure their profit; 
i.e., they figure that if a certain commodity which costs them 
$100 is resold for $125, the profit on the sale amounts to $25. 
They assume that they have then arrived at a constant margin 
of profit, without considering another pertinent factor. 

Suppose that a merchant makes two sales of a commodity 
for $125 each, which he purchased for $100, and that the first 
buyer paid cash, but the second buyer did not pay for 90 days. 
Is his profit on the two sales the same? Suppose he made 
1,000 such sales a year to each of these merchants, would he 
derive the same net profit at the end of the year from both 
accounts ? 


205 


206 


INCIDENTAL CREDIT FACTORS 


This is precisely the situation that a merchant or manu¬ 
facturer has to consider in marketing his goods. As a further 
illustration let us take the following three cases and see what 
the real significance of this factor actually amounts to: 

1. A, a manufacturing concern, whose regular terms of pay¬ 
ment are 30-1 -10, sells B a bill of goods amounting to $500 on 
June i, and B discounts the bill within the 10 days. 

2. A similar sale is made to C, who pays promptly at matur¬ 
ity (July 1). 

3. A third sale is made to D, who does not pay until 60 days 
after maturity (September 1), when A threatens to place the 
account in the hands of an attorney for collection. 

Consider now the consequences resulting from such a vari¬ 
ation in the manner of payment from two points of view: 

1. As affecting the manufacturer’s profit derived from the 

sale. 

2. In molding his opinion of the purchaser as a credit risk. 

Manufacturer’s Profit as Affected by Time of Payment 

In order to emphasize the point to be brought out, it will 
facilitate matters considerably to view the situation as of the 
time of D’s payment—September 1. By that time A will have 
had the use of B’s $495 ($500 less the 1 per cent discount) 
from June 10 to September 1, and assuming he is realizing 
an average rate of 20 per cent on his working capital, this will 
amount to $22 for the 80 days, so that he will then have 
realized $517 on the sale to B. Likewise he will have realized 
$16 on the use of the $500 received from C July 1, or $516.66 
in all. 

Before proceeding further it might be interesting to make 
a comparison between the profit derived from the sale to B, 
who discounts his bills, and the one to C, who pays promptly 
at maturity. In the former instance A receives $495 on the 
tenth day. The use of this money as a part of A’s working 
capital for the next 20 days at 20 per cent nets him $5.55, 


MANNER OF PAYMENT 207 

4 

or a total of $500.55, as contrasted with the $500 received 
from C at maturity. In other words, the difference amounts 
1° 55 cents a month on $500 worth of business, or, assuming 
B and C are handling A’s product exclusively, and regularly 
purchase $500 worth of goods a month, the difference 
amounts to: 


$ 6.60 on $ 500 worth of business a year 

13.20 “ 1,000 “ “ “ 44 “ 

132.00 44 10,000 “ “ 44 “ “ 

1,320.00 “ 100,000 44 44 “ 44 44 

13,200.00 44 1,000,000 “ 44 44 44 44 

On September 1, when A receives D’s check for $500, he 
has realized $517 from his sale to B, $516.66 from his sale 
to C, and $500 from his sale to D, or approximately $17 differ¬ 
ence between the sale to the one who discounts his bills and 
the one who pays promptly at maturity, and the third purchaser 
who takes 60 days’ overtime. Extended, this amounts to a dif¬ 
ference of: 


$ 34 on a $ 1,000 sale, 90-day payment 

340 44 44 10,000 “ 44 44 44 

3,400 “ 44 100,000 “ “ “ 44 

34,000 4 4 4 4 /1,000,000 4 4 4 4 4 4 44 

While the illustration used cannot be regarded as an 
extreme case, the result will serve to emphasize the fact that 
altogether too little importance is attached to the advantage 
and the profit derived from close collections. Particularly is 
this true since the increase in competition and corresponding 
decrease in the margin of profit in business today no longer 
permits long-time credits in domestic trade. The merchant in 
his function of creditor cannot afford to ignore so important 
a factor in his business, or to lose sight of the fact that there 
is no profit in a sale until the bill has been paid, and that, conse¬ 
quently, the longer the bill remains open after maturity, the 
smaller the profit will be. 


208 incidental credit factors 

Effect of Manner of Payment on Purchaser’s Standing 

On the other hand, it is equally true that altogether too 
little importance is attached by customers to the effect the 
manner in which they pay their bills has on their credit stand¬ 
ing. That a premium is to be placed on the business of the 
man who discounts his bills, or pays promptly at maturity, 
is perfectly obvious from the foregoing. To just what extent 
this element should influence a credit man in estimating a credit 
risk may be ascertained by considering the following two 
examples: 

1. Suppose you had a horse you wished to sell for $250 and 
the only man willing to give $250 for the animal offered his 60- 
day note in payment. The chances are greatly in favor of your 
accepting the note. 

2. Suppose, however, there were two men willing to pay you 
$250 for the horse, one with a 60-day note and the other cash 
in 10 days. Then you would of course part with the horse to 
the latter. 

The same principle of discrimination may be said to apply 
to business in general. If a concern could find sufficient cus¬ 
tomers willing and able to discount bills of sale covering their 
entire production, even the business of the man who pays 
promptly at maturity would be declined. On the other hand, 
if the output is sufficiently large (and it almost always is) to 
more than supply such cash customers, the business of the 
slower paying customers then, and then only, becomes attrac¬ 
tive; or, couched in the phraseology of what may be termed a 
credit maxim, “the slower the pay, the less attractive the busi¬ 
ness,” and, consequently, the larger the credit lines extended 
to those who pay their bills promptly. 

Cost of Collection 

There is still another very good reason for this. It costs 
money to carry slow accounts, in that it takes time on the part 
of the credit manager to formulate the policy for handling 


MANNER OF PAYMENT 


209 


nearly every collection and then to dictate the correspondence; 
time of the stenographer to write the collection letters; time 
of the file clerk in caring for them—to say nothing of the items 
of postage and stationery which, over a period of six months 
or a year, is no small item. The total cost constitutes a sum 
of sufficient size to justify giving serious consideration to the 
formulation of a definite policy in handling the accounts of the 
“slow-pay.” A credit manager once said, when it was merely 
intimated what a joy it would be to be able to refuse to sell 
anyone on open terms who did not pay his bills promptly, 
“If I could be assured that we wouldn’t lose any money by 
adopting such a policy, the very first thing I would do would 
be to cut down my office force from eight to three—a 
stenographer, an assistant, and myself.” 

Finally, with all due respect to the vigilance exercised by 
credit men in watching their accounts, the percentage of losses 
which can be attributed to carelessness is unjustifiably large. 
In other words, the high percentage of loss from bad debts 
in a firm’s accounts may, as a rule, be attributed more to care¬ 
lessness in following an account (such as failure to check over 
and revise the credit data frequently, delay in following up 
overdue accounts, and neglect in enforcing prompt collections) 
than to any lack of judgment in opening the account. Par¬ 
ticularly is this true where a series of prompt payments has 
thrown a credit man off his guard and has caused him to re¬ 
gard what was originally considered a doubtful risk as a good 
account, and to allow an order to slip through here and there 
which eventually is entered in the loss ledger. 

Such carelessness is oftentimes due to the credit man being 
so overwhelmed with detail work that he has insufficient time 
to devote to the study and consideration of the doubtful ac¬ 
counts—a fault of the system rather than of the man. The 
eradication of carelessness in such instances is to be ac¬ 
complished by proper corrections and adjustment in the dis¬ 
tribution or manner of handling the work. There are thus 


210 


INCIDENTAL CREDIT FACTORS 


sources of loss and error in credit work other than the judg¬ 
ment of the credit man, and the fact should never be overlooked 
that the avoidance of a loss is equivalent to making a profit. 
Consequently, the failure to avoid a loss is just as bad as the 
failure to make a profit. The net result is the same whether you 
break the eggs or whether you find they are not in your basket 
when you look for them. 

Classification of Customers 

For the purpose of identification it has been found con¬ 
venient to classify customers according to the manner in which 
they pay their bills, as follows : 

Discount—only about 25 per cent of business concerns are 
said to discount their purchase bills all the time. 

Prompt-pay—pay promptly at maturity. 

Slow-pay—accustomed to taking overtime. 

Poor-pay—do not pay until they must. 

Cash, or sight draft—unworthy of credit for any amount. 

1. The first class requires no explanation whatsoever. 
Suffice it to say that in the eyes of the credit men this class of 
customers constitutes the cream of the business world. 

2. The second likewise requires little consideration. They 
need no watching and no prodding—merely an occasional check 
to see that no change has taken place in the manner of handling 
the account. 

3. “Slow-payers,” as Mr. Higginbotham, formerly credit 
manager of Marshall Field and Company, says, are especially 
troublesome. The credit man may know them to be perfectly 
good and safe, but because of carelessness, or because they are 
just chronically and habitually slow, they are forever letting 
their bills become overdue. The credit man must work with 
these men personally—educate and train them to proper busi¬ 
ness methods, even to the extent of coercion when friendly 
measures fail. 

It should at all times be borne in mind by the collector 



MANNER OF PAYMENT 


211 


that persistence plays a most important part in the education 
of slow-paying customers to pay promptly, and, as we have 
seen, the relation which the prompt collection of accounts bears 
to the reduction of losses and increased profits cannot be over¬ 
estimated; whereas the converse is also equally true, that a 
good account may easily be turned into a bad, or at least a 
doubtful one, by a little inattention at the proper time. 

The constituents of this third class are quite numerous, 
varying in degree from the little slow, or those who meet their 
obligations with a fair degree of promptness (pay within 30 
to 50 days), to the very slow, or those who delay payment as 
long as possible without being dragged into the law courts. 
Their business, however, may be said to be attractive to the 
average manufacturer, requiring only careful and constant at¬ 
tention. Moreover, salesmen will bear witness to the fact that 
that there is keen competition for the trade of the slow-pay, 
particularly those who are classed as “good but slow.” 

4. The class of customers constituting the fourth class, the 
poor-pay, consists of delinquent debtors, who for the most part 
are responsible but whom the merchant is generally obliged to 
sue in order to get his money. The accounts of such cus¬ 
tomers are bad assets, to say the least, for although the pros¬ 
pects are in favor of eventually collecting the account, it is 
going to cost money. 

5. As to the last class, it is made up of merchants unworthy 
of credit, because of their lack of credit responsibility or other 
attributes essential to the extension of credit; or who have 
proved themselves members of that class of merchants ready 
and willing to abuse a line of credit in any way or manner 
possible. The business of this class is therefore undesirable 
on any basis other than cash in advance, or shipments made 
subject to a “sight draft drawn with bill of lading attached.” 
To extend credit to such a class of customers is practically 
equivalent to buying a lawsuit. 


CHAPTER XVIII 

THE SECURING OF ACCOUNTS 


Guaranty and Suretyship 

A good credit man will try to fill every order that is re¬ 
ceived, and when conditions do not justify making shipment 
on open terms he will endeavor either to obtain payment in 
advance or authority to ship the goods subject to a sight draft 
drawn with bill of lading attached (SD/BL), which is de¬ 
posited with some local bank by the seller and forwarded to a 
bank in the customer’s city for collection. Upon receipt of 
the draft with the bill of lading attached, the local bank noti¬ 
fies the customer, and upon receiving payment of the amount 
for which the draft is drawn it turns over to him the bill of 
lading, thereby making it possible for him to obtain the goods 
from the carrier. The bank then remits the amount collected 
to the seller through the bank from which it received the draft 
for collection. 

In event the customer objects to having his orders filled in 
either of these ways, it is often possible to arrange to have the 


To (name of creditor) 

If you will let B have the following goods: 


I will guarantee the prompt payment for them. 

Signed 


Form io. Informal Guaranty 


212 








THE SECURING OF ACCOUNTS 


213 


account secured by someone of greater responsibility who is 
willing to obligate himself as guarantor or surety of the ac¬ 
count up to a certain amount. In some cases this is provided 
for by means of a simple letter from the guarantor to the seller, 
stating that the guarantor will insure payment of the account 
up to a certain amount (Form 10). In others a formal guar¬ 
anty is drawn up on forms provided for that purpose 
(Form 11). 


Cincinnati, Ohio 

To (name of creditor) 

For value received, I hereby guarantee the prompt payment, to The 

Armour Packing Co., of the account of. 

which is or may become due them, to the extent of $., hereby 

waiving notice of the extension of credit or delinquency of payment. 

This guaranty to continue until removed by me in writing. 

Signed 


Form 11. Formal Guaranty 

Distinction between Guaranty and Surety 

Although the terms are not always used with precision 
and are used almost interchangeably there is a distinction be¬ 
tween the two forms of obligation of guaranty and surety 
that should be observed. Guaranty is a conditional promise 
to answer for the debt of another in event the principal debtor 
cannot be compelled to pay. It is to this effect—“I will pay 
in case he can not.” The guarantor is the one who gives the 
guaranty; the guarantee is the one to whom the guaranty is 
given, or the creditor; the principal is the one whose debt is 
guaranteed, the debtor. Surety is a promise to become equally 
liable with the principal for the payment of the debt, being to 
this effect—“I will pay in case he does not.” 

While the two obligations are very similar and the object 
of both is the same, namely, that of binding one person for 
the benefit of another, there are differences in their liabilities: 






214 


INCIDENTAL CREDIT FACTORS 


1. The contract of a guarantor is his own separate under¬ 
taking, whereby he agrees to perform the obligation in case 
the principal cannot be compelled to, and his liability does not, 
therefore, accrue until all rights against the debtor have been 
exhausted by the principal. Perhaps a better conception of the 
relation thus created can be gained by remembering that at the 
outset a guaranty is a contract but not a debt. 

2. A surety binds himself equally with his principal for the 
due performance of the obligation and is liable from the be¬ 
ginning ab initio. He is therefore not entitled to notice of 
default of the principal, and if the obligation is not met 
promptly, he can be sued immediately. The legal relationship 
of the three parties in a guaranty and a surety may be repre¬ 
sented graphically as follows: 


Seller 


Buyer 


Guarantor 


Seller 


Distinction between Guaranty of Payment and Guaranty of 
Collection 

However, the obligation undertaken by a guarantor may 
be either a guaranty of payment or a guaranty of collection. 
The distinction is important because in the first case the guar- 







THE SECURING OF ACCOUNTS 215 

antor agrees to pay if the principal debtor does not, whereas 
in the second he agrees to pay only when it has been demon¬ 
strated that the debt cannot be collected from the principal. 
So as concerns the credit man, a guaranty of payment cor¬ 
responds in effect to a surety obligation, because upon default 
in payment the creditor has the right to proceed against the 
guarantor immediately. 


Continuing Guaranty 

A continuing guaranty is an agreement whereby the guar¬ 
antor agrees to be responsible for goods purchased by the prin¬ 
cipal from time to time in the future; and in which a maximum 
amount is almost always stipulated, beyond which the guarantor 
will not be bound (Form 12). 


For Value Received, and in consideration of The Cudahy Packing 
Co., selling and delivering to . 


of . such meats, provisions, and other 

of their products as.may order from time to time,. 


Do Hereby Guarantee the payment to the said The Cudahy Packing 
Co., at maturity of bills, or at any time thereafter on their demand, for 

all such purchases made by the said. 

during the period of.years from the date hereof, to the amount 

of. Dollars. 

That.guaranty herein expressed is for a running account 

against the said . and is a continuing 

guaranty for the payment of any sum, or sums, owing thereon to the 

aforesaid sum of. Dollars. Hereby waiving notice 

of acceptance of this guaranty, notice of maturity of purchases, and default 
in payment. It is expressly understood that any indebtedness of the said 

. to The Cudahy Packing Co., over 

and above and in excess of the aforesaid sum of. 

Dollars is at the risk of The Cudahy Packing Co., but such additional 

indebtedness will not alter or vitiate .guaranty expressed for 

the said sum of. Dollars. 

Dated at.this.day of. 19.... 

Witness: 

.[Seal] 


Form 12. Continuing Guaranty 






















2 l6 


INCIDENTAL CREDIT FACTORS 


Consideration 

When the contract of guaranty is entered into at the same 
time as the contract of sale which it guarantees, no special 
consideration is necessary to support the promise of the guar¬ 
antor. When, however, the contract of guaranty is made sub¬ 
sequent to the contract of sale, a new consideration moving 
from the creditor is required to make the guaranty binding. 

Example: Suppose A writes to C: “If you will fill the 
following order for B, I will guarantee payment for the goods.” 

The filling of the order constitutes sufficient consideration to 
support C’s promise. 

Suppose, however, the order has already been filled when A 
writes C: “I hereby guarantee B’s debt to you.” This promise 
would be unenforcible for lack of consideration to support it. 

If, however, such promise were given in consideration for an 
extension of time to B in which to pay, the promise of C would 
be binding. 

Notice of Acceptance by Guarantee 

Where the contract of guaranty is entered into at the same 
time as the contract of sale, no notice by the guarantee that he 
accepts the guaranty is necessary. In the case of a continuing 
guaranty, where A, the guarantor, insures C payment for all 
goods sold to B during the ensuing year, the authorities are 
somewhat divided as to whether C must notify A that he 
accepts the guaranty, or whether the filling of the order con¬ 
stitutes an acceptance. The weight of authority seems to hold 
that notice must be given in such a case. However, in view 
of the conflict of authority, it is always advisable to notify the 
guarantor that his guaranty had been accepted. 

Notice to Surety and Guarantor on Default of Principal 

Unless otherwise expressly specified in the agreement, a 
surety is not entitled to notice in case the debtor fails to fulfil 
his obligation. Whether the creditor must notify the guar¬ 
antor that the debtor has defaulted in payment, is a disputed 


THE SECURING OF ACCOUNTS 


217 


question. Some states require no notice, while others do. It 
is generally held, however, that a guarantor is entitled to notice 
of default within a reasonable time after the default occurs; 
also, that the creditor should first use due diligence to compel 
performance by the principal debtor before proceeding against 
the guarantor. Consequently, if the guarantor can show that 
he suffered any loss by reason of his failure to receive such 
notice, the weight of authority is to the effect that he can escape 
liability, unless it is otherwise expressly agreed in the contract 
of guaranty. By “due diligence” is meant that the creditor 
shall bring suit against the debtor promptly upon default, 
and shall use the customary process of court to obtain satis¬ 
faction of his claim. In many jurisdictions it has been held, 
however, that if the debtor is insolvent, the creditor need not 
sue. 

As in the case of giving notice of acceptance, the prudent 
course to pursue under the circumstances is for the creditor to 
notify the guarantor of the fact that there has been a default 
in payment by the debtor and that the creditor looks to the 
guarantor for payment. 

Discharge of Guarantor 

The guarantor is released from his obligation by the fol¬ 
lowing : 

1. Alteration of Contract. A guarantor can be held 
liable on his contract of guaranty only as he made it. If the 
creditor and principal debtor agree to make any change in it, 
without the consent of the guarantor, the latter will cease to be 
liable. 

2. Release of the Debtor. If the creditor releases the 
debtor from his obligation, intending to look to the guarantor 
for payment, such a release also discharges the guarantor, un¬ 
less he consents to it. An involuntary release on the part of 
the creditor, such as a discharge in bankruptcy, constitutes an 
exception. 


2 l8 


INCIDENTAL CREDIT FACTORS 


3. Extension of Time to Debtor. If the creditor 
grants an extension of time in which to pay to the debtor, 
without the consent of the guarantor, the latter is discharged. 
This ground of release is sometimes anticipated and avoided 
by means of a provision in the contract which permits a change 
in the original terms of sale between the seller and purchaser. 

4. Surrender of Securities by Creditor. If the debtor 
surrenders securities held as collateral for the payment of the 
debt, the guarantor is discharged to whatever extent he may 
be injured as a result of it. 

5. Death of Guarantor. If the guarantor dies before 
the contract of guaranty has been acted upon by the creditor, 
the death of the guarantor has the same effect as an express 
revocation. If, however, the creditor has incurred any liabil¬ 
ity under the agreement, the guarantor being answerable 
therefor at the time of his death, his estate also remains liable 
therefor. After the death of the guarantor, however, no 
further credit may be extended in reliance on his guaranty, but 
his estate remains answerable for whatever indebtedness has 
already been incurred. 

6. Main Contract Unenforcible. If the main con¬ 
tract between the creditor and debtor is illegal and therefore 
unenforcible against the debtor, for such causes as fraud, a 
usurious rate of interest, illegality, etc., it is likewise unen¬ 
forcible against the guarantor. Where the contract is void¬ 
able, the fact that the debtor is an infant, or a person of un¬ 
sound mind, will not release the guarantor. Such a defense is 
personal to the debtor, and the guarantor may not avail him¬ 
self of it. 

Remedies of Guarantor 

A guarantor who has paid the obligation of the debtor is 
entitled to the following remedies: 

1. Subrogation to Rights of Creditor. After satisfy¬ 
ing the creditor’s claim, the guarantor is entitled to be sub- 


THE SECURING OF ACCOUNTS 


219 


rogated to the rights and collateral securities held by the 
creditor to secure payment of the debt. 

2. Indemnity Against Principal. After the guarantor 
has paid the debt to the creditor, he is entitled to turn around 
and collect it, if possible, from the debtor. 

3. Contribution. If two or more persons are jointly 
liable on a contract of guaranty, and one of them pays the 
entire debt, he is entitled to a pro rata reimbursement or con¬ 
tribution from the other coguarantors. 

Disability of Bank 

A bank cannot guarantee an account, because it cannot be 
legally bound under such an agreement. However, any as¬ 
sumption of risk, or assurance of protection short of an actual 
guaranty, creates a strong moral obligation. 

Statute of Frauds 

The obligations of both guaranty and surety must be in 
writing to be enforcible. Section 4 of the Statute of Frauds 
provides :—“all undertakings to be answerable for the debt, de¬ 
fault, or miscarriage of another must be in writing to be 
enforcible. ” 



CHAPTER XIX 


CHATTEL MORTGAGES 

Definition and Nature 

In arranging for the extension of a line of credit to some 
buyer of doubtful responsibility, it is not an uncommon prac¬ 
tice for credit men to accept a chattel mortgage (Form 13) 
as collateral security on the account. It also not infrequently 
happens that in investigating the financial responsibility of a 
merchant or firm it is found that the personal property owned 
by the merchant is covered by one or more chattel mort¬ 
gages. 

A chattel mortgage in most jurisdictions is an instrument 
whereby the owner of personal property transfers title to such 
property to another as security for the payment of a debt, 
subject to being defeated upon payment of the debt. The legal 
title is vested in the mortgagee and becomes absolute upon 
default. Such title, however, is extinguished by the payment 
of the debt by the mortgagor. 

A chattel mortgage differs from a mortgage upon real 
estate in the following particular: A real estate mortgage is 
only a lien and conveys no title, whereas a chattel mortgage 
transfers the title at once, subject to a defeasance by the per¬ 
formance of the obligation for which it was given. However, 
the law in regard to chattel mortgages differs materially 
throughout the states. While in most states a chattel mort¬ 
gage is regarded as an absolute transfer and conveyance of 
the property, there are some states in which it is held that title 
does not pass to the mortgagee, but that he gets only a lien on 
the mortgaged property. 


220 


CHATTEL MORTGAGES 


221 


Chattel Mortgage 

Know All Men by These Presents: 

That I, Harry J. Thomas, of New Rochelle, New York, am indebted 
unto W. H. Richards, of New York City, New York, in the sum of 
Eighty-Five Dollars ($85), being for goods sold and delivered to me: 
Now, for securing the payment of the said debt, and interest from the 
date hereof, to the said W. H. Richards, I do hereby sell, assign, and 
transfer to the said W. H. Richards all the goods, chattels, and property 
described in the following schedule, namely. 

(List of property) 

Said property now being and remaining in the possession of myself, at my 
store, No. 165 Orchard Street, New Rochelle, New York. 

Provided always, and this mortgage is on the express condition, that 
if the said Harry J. Thomas shall pay to the said W. H. Richards the sum 
of Eighty-Five Dollars ($85), within one year and six months from the 
date hereof, with interest at Six per cent (6%) per annum, which said 
sum and interest the said Harry J. Thomas hereby covenants to pay, then 
this transfer is to be void and of no effect; but in case of non-payment of 
the said sum at the time or times above mentioned, together with interest, 
then the said W. H. Richards shall have full power and authority to enter 
upon the premises of the said party of the first part, or any other place 
or places where the goods and chattels aforesaid may be, to take possession 
of said property to sell the same, and the avails (after deducting all 
expenses of the sale and keeping of the said property) to apply in payment 
of the above debt; and in case the said W. H. Richards shall at any time 
deem himself unsafe, it shall be lawful for him to take possession of such 
property and sell the same at public or private sale, previous to the time 
above mentioned for the payment of said debt, and apply the proceeds as 
aforesaid, after deducting all expenses of the sale and keeping of said 
property. If from any cause, said property shall fail to satisfy said debt, 
interest, costs, and charges, the said Harry J. Thomas hereby covenants 
and agrees to pay the deficiency. 

In Witness Whereof, I have hereunto affixed my hand and 
seal, this eleventh day of February, nineteen hundred and 
twenty. 


Harry J. Thomas [l.s.] 


In the presence of : 

George H. Goodwin 

(Notarial acknowledgment in due form if required) 


Form 13. Chattel Mortgage 


Form and Requisites 

In the absence of statute no particular form is necessary 
to constitute a chattel mortgage. The simple statement that a 
creditor is to have a lien and that on default he may take 
possession, sell the property, and apply the proceeds upon the 
lien, is sufficient. In other words, any form of words by which 
the title is transferred as security for a debt or obligation of 
any kind, to be defeated by the payment of the debt or perform- 


222 


INCIDENTAL CREDIT FACTORS 


ance of the obligation, suffices to serve as a chattel mortgage. 
Statutes have been passed in practically all states, however, 
requiring the recording of chattel mortgages in order to make 
them valid and enforcible against third parties. 

Parties 

All persons who are legally competent to make a contract 
may also make a chattel mortgage. A man may make a valid 
chattel mortgage to his wife. A chattel mortgage may be 
executed by an agent who is authorized for the purpose, and 
his authority may be either verbal or written, or by way of 
subsequent ratification. A member of a firm may, without 
the knowledge and consent of his partners, make a chattel 
mortgage, covering the partnership property, in the firm name 
to secure a firm debt. 

Subject Matter 

It may be stated generally that every kind of personal 
property may be mortgaged. For example, a life insurance 
policy may be the subject of a chattel mortgage. A chattel 
mortgage simply requires a subject in existence, together with 
an ownership and control in the mortgagor, and can have no 
validity where the property is not in either actual or potential 
possession of the mortgagor. 

Description of Property 

The general rule as to description of the mortgaged prop¬ 
erty is that any description will suffice that will enable third 
persons to identify the property by inquiries and evidence. A 
chattel mortgage conveying “all personal property whatever 
owned by the mortgagor” is too indefinite and cannot be said 
to give notice of the lien to execution creditors. A general 
description covering all the goods in a store and stock in trade 
has been held to constitute a sufficient description. However, 
when made to include “all increase and decrease thereof,” it 


CHATTEL MORTGAGES 


223 


has been held to be void. Several states have passed statutes 
providing that a chattel mortgage on a stock of merchandise 
subject to resale is fraudulent and void. Other states hold that 
such a mortgage is valid if it requires the mortgagor to apply 
the proceeds derived from a resale of the goods to the satisfac¬ 
tion of the mortgage debt. Where a schedule of the property 
is annexed to the mortgage, it becomes a part of it and both 
are construed together. Where there is a conflict between the 
two, the provisions of the mortgage prevail. 

Execution and Delivery 

Delivery and acceptance are essential to constitute a valid 
mortgage. There must be some act showing that the grantor 
intends that it shall take effect and that act constitutes delivery 
to the grantee, actual or presumed. Merely to sign and ac¬ 
knowledge a writing and then retain it in one’s possession, 
conveys no title. 

The date recited in a chattel mortgage is only prima facie 
evidence of the time of its execution and the true date may be 
shown by oral evidence. 

Filing 

If the possession of the chattel property, as well as the title 
or the lien, always passed to the mortgagee, few questions 
would arise of interest to others than the immediate parties, 
unless the whole transaction could be attacked as a fraud upon 
the mortgagor’s creditors. But if the mortgagor, as is fre¬ 
quently the case, is to remain in possession of the chattel, the 
rights of third persons who, without actual notice of the mort¬ 
gage or lien, purchase the chattel from the mortgagor in 
possession, or who otherwise change their position, relying 
on the apparent ownership attributable to unrestricted posses¬ 
sion and control of the chattel, may easily become involved. 1 

In order to avoid this, filing and recording statutes have 


1 Credit Men’s Manual of Commercial Laws, p. 114. 



224 


INCIDENTAL CREDIT FACTORS 


been enacted in practically all the states, making it possible for 
the mortgagee not in possession to protect himself against the 
claims of subsequent purchasers or subsequent mortgagees. 
Under these acts the filing or recording of the mortgage in the 
proper office of record serves as notice to the world of the 
mortgagee’s interest in the chattels. That of New York affords 
a typical example, and provides: 

Every mortgage or conveyance intended to operate as a 
mortgage of goods and chattels hereafter made, which shall not 
he accompanied by an immediate delivery and be followed by an 
actual and continued change of possession of the things mort¬ 
gaged, shall be absolutely void as against the creditors of the 
mortgagor, and against subsequent purchasers and mortgagees 
in good faith, unless the mortgage, or a true copy thereof, shall 
be filed as directed. 

Every mortgage filed in pursuance of this act shall cease to 
be valid as against the creditors of the person making the same, 
or against subsequent purchasers or mortgagees in good faith, 
after the expiration of one year from the filing thereof, unless 
within 30 days next preceding the expiration of each and every 
term of one year after the filing of such mortgage, a statement 
describing the mortgage, stating the names of the parties .... 
shall be again filed in the office of the clerk aforesaid .... 

The term of filing varies from one year in New York and 
Michigan to six years in Minnesota. 

Where Filed 

The actual place of residence of the mortgagor is, with 
few exceptions, the place where a chattel mortgage must be 
filed, and creditors of the mortgagor, subsequent purchasers, 
and mortgagees in good faith, may show that the place men¬ 
tioned in the mortgage as his residence was not such in fact. 
However, the general creditors of a mortgagor of chattels have 
no right to assail a mortgage as invalid until they have secured 
a lien thereon by levy under a judgment and execution, or by 
some other method acquired a legal or equitable interest in the 
property. 


CHATTEL MORTGAGES 


225 


Effect of Omission to File 

A failure to file a chattel mortgage where there has been 
no change of possession of the mortgaged property renders 
it void as to the existing creditors of the mortgagor, and the 
mortgagee cannot thereafter acquire title to the property by 
taking possession and selling it under the mortgage, although 
the mortgage was given in good faith to secure an actual 
indebtedness. In fact, the courts have gone still further and 
held that such a mortgage is not valid as against an antecedent 
creditor, although it was filed before the creditor acquired a 
lien upon the property by judgment and execution. However, 
a mere creditor at large, without some process for the collec¬ 
tion and enforcement of his debt, is not in a position to ques¬ 
tion an unfiled mortgage given by his debtor, which is other¬ 
wise valid. 

How Discharged of Record 

Whenever the mortgagor, or any person obtaining title to 
mortgaged property, shall present to the recorder in whose 
office a chattel mortgage is filed, a certificate (“satisfaction 
piece”) from the mortgagee, or the holder thereof, to the 
effect that such mortgage has been paid or satisfied, it is the 
duty of such recorder to file such certificate in his office and 
discharge the mortgage, by writing in the record opposite the 
entry the word “discharged” with the date thereof. 

Distinction between Chattel Mortgage and Conditional Sale 

A chattel mortgage is sometimes said to be in essence a 
“conditional sale with a condition subsequent to the passing 
of title.” The mortgagee of goods becomes the transferee of 
the legal title subject, however, to defeasance upon perform¬ 
ance by the mortgagor of the condition imposed by the mort¬ 
gage; but if for any reason the mortgagor fails to perform 
the condition imposed by the mortgage, the title of the mort¬ 
gagee then becomes absolute. The interest retained by the 


226 


INCIDENTAL CREDIT FACTORS 


mortgagor in such cases is in the nature of a lien, or equity 
of redemption. In the case of a conditional sale, however, the 
seller retains something more than a lien; he actually retains 
the legal ownership, after the possession of the property passes 
into the hands of the purchaser, and he may, upon the failure 
of the purchaser to keep his contract, recover actual possession. 
A chattel mortgage transfers title, and may or may not transfer 
possession, while a conditional sale transfers possession but 
not title. 

Distinction between a Conditional Sale and a Pledge 

From a strictly legal point of view, the nature of both the 
conditional sale and the pledge is apparently the same, in that 
possession but not the legal title is transferred in both instances. 
The distinction, however, lies in the fact that the obligation 
flows in the opposite direction in the case of a pledge from that 
in the case of a conditional sale, as shown in the subjoined 
diagrams: 


Pledge 

Owes 

Pledgor- > Pledgee 

(one out of possession) (one in possession) 

Conditional Sale 
Owes 

Seller < “ ~ Purchaser 

(one out of possession) (one in possession) 

Also, in the nature of the remedy for a breach or non¬ 
performance of the obligation involved, in that the pledgee 
may collect what is due him by a sale of the property pledged; 
whereas the seller, in the case of a conditional sale, may retake 
or recover the property. 2 

2 For a complete digest of the state statutes on chattel mortgages see Credit Men’s Manual of 
Commercial Laws, p. 120. 





CHAPTER XX 

CREDIT INSURANCE 


Defined 

The theory of credit insurance, for some reason, is often 
misunderstood and there has been a tendency to criticize its 
principle for faults which are due to poor methods in applying 
and carrying out the principle in practice. Properly presented, 
however, the principle is as easily grasped as that of any other 
form of insurance, and it is a subject which should be given 
due consideration by every credit man. 

The principle underlying insurance of all kinds is the same, 
namely, that of equitably distributing the excessive or unex¬ 
pected losses of a few among a large number, each of the 
policyholders paying a fixed premium for having his risk of 
loss assumed by the others. In other words, all insurance is 
based on the law of averages, and credit insurance is simply 
the application of this principle to bad debt losses. Credit 
insurance may then be defined as the application of the prin¬ 
ciples of indemnification for losses to the risk incurred in the 
extension of mercantile credit. 

The Initial Loss 

All sales or transfers of goods on credit involve some risk 
of loss to the party extending the credit, and when these risks 
are accepted from day to day over an extended period, the 
creditor anticipates losses from some of them and provides 
against these expected losses by setting up a reserve or special 
allowance to cover such losses. The amount to be set aside 
for this purpose is ascertained by computing the average per¬ 
centage of loss over past years, and then making allowance 


227 


22& 


INCIDENTAL CREDIT FACTORS 


for the same percentage on the estimated volume of sales for 
the coming year. This normal loss, averaged from previous 
years’ figures, properly constitutes a part of the expense of 
doing business, and should be considered as such along with 
the other production costs. In other words, a certain normal 
loss figured in advance is, under such circumstances, not a loss 
at all, but an anticipated part of the expense of doing business 
on credit, which may be added to the sale price of the goods. 

Scope of Credit Insurance 

In addition to this normal or initial loss which the house 
itself must sustain, business done on credit is always subject 
to unexpected and unlooked for losses due to financial difficul¬ 
ties brought about by crop failures, floods, business depres¬ 
sions, or other natural causes, which nothing short of divine 
foresight could have anticipated, and it is only against this 
abnormal or excessive loss that the insurance company affords 
protection to the policyholder. In other words, credit insur¬ 
ance does not insure a merchant for his total loss, but against 
abnormal losses only. 

In negotiating for credit insurance three things must be 
determined: 

1. What sum shall be fixed as the normal loss of the house 

seeking credit insurance, above which losses will be 

indemnified ? 

2. What rate or premium shall be charged by the insurance 

company ? 

3. What shall be the fixed limit of indemnification beyond 

which the company will not be bound ? 

Ascertaining the Initial Loss 

As has already been explained, to fix the amount of the 
initial loss to be borne by the insured, the net losses for several 
years back are compared with the volume of sales for each of 
these years, in order to determine the average percentage of 


CREDIT INSURANCE 


22 9 


loss from year to year. For example, if the sales for the past 
five years averaged $1,000,000, and the losses during the same 
period averaged y 2 per cent, the initial or normal loss to be 
borne by the insured would be fixed at $5,000, the insurance 
company being liable only for such losses as are in excess of 
$5,000. 

Another method that is sometimes used for computing the 
known, or initial, loss consists in dividing the total losses from 
bad debts for the preceding five years by five, and the quotient 
is taken as the initial loss. 

Determining the Insurance Premium 

As in the case of other forms of insurance, the premium or 
rate varies with the degree of risk involved. In credit insur¬ 
ance the basis used for estimating the degree of risk consists 
of a fixed schedule of rates for each class of business, based on 
statistics of failures running over a number of years, and 
carefully compiled by the mercantile agencies. These tables 
correspond to and are used in a manner similar to the mortality 
tables of life insurance companies. In addition to this general 
information, consideration is also given to the particular 
hazards of the business of the insured, their class of customers, 
the volume of business, size of accounts, terms of sale, and the 
general credit policy of the house. From all these facts the 
premium rate is determined. 

An additional premium is sometimes necessary and is 
adjusted according to the volume of sales. Where such 
additional premiums can be collected, the policy is called 
“assessable.” 

Limitations of the Bond 

Credit insurance, as has already been pointed out, presup¬ 
poses a willingness on the part of the insured to assume a 
normal or initial loss. A further restriction incorporated in 
the policy is that the extent to which protection is afforded 


230 


INCIDENTAL CREDIT FACTORS 


against loss sustained in selling customers who are not rated, 
or poorly rated, by Bradstreet or Dun, is limited. Both of 
these agencies make use of the classification of “rated” and 
“off-rated” accounts, the former ccmsisting of those having 
a capital rating followed by a first- or second-class credit rating, 
and the latter consisting of those having a lower rating than 
the former, or none at all. Statistics show that the heaviest 
losses are sustained from the off-rated class of accounts, and 
for this reason the insurance company limits its liability on 
off-rated accounts by stipulating that only a certain percentage 
of the bond shall apply to such accounts in figuring the year’s 
losses. 

Types of Policies 

Two principal types of policies are being written, one 
known as the “limited,” and the other the “unlimited.” 

The limited policy is one having a face value which is the 
maximum total liability of the insurer. Thus, if the policy 
has a face value of $25,000 and the insured sustains losses 
aggregating $50,000 he is only partially insured even though 
all the loss accounts were within conservative credit limits. 

The unlimited policy makes no provision for a maximum 
total liability and has no face value. As long as the individual 
losses come within the amounts specified in the table of ratings, 
contained in the policy, they will be paid regardless of the total 
amount. 

Both types are written with many‘variations. But no loss 
is covered under a policy unless the agency rating of the debtor 
to whom the goods were shipped shall have been within the 
table of ratings contained in the policy. If the name of the 
debtor does not appear in the latest published book, then the 
latest report of said agency shall govern, if that report is within 
a specified time of shipment (usually this is three or four 
months) / 


1 See Riegel and Loman, Insurance Principles and Practice, p. 324. 



CREDIT INSURANCE 


231 


Method of Operation 

To illustrate the method of operation employed by credit 
insurance companies, let us assume that a firm’s gross sales 
over a period of five or ten years have averaged $500,000 a 
year, and that the percentage of loss suffered during the same 
period amounted to *4 per cent, or $2,500. In such a case, if 
the aggregate loss from bad debts is less than $2,500, the firm 
recovers nothing in the nature of indemnity from the insur¬ 
ance company. If the loss exceeds $2,500, the excess is recov¬ 
ered in full up to the amount of the bond, subject to the above 
restrictions. For example, it may provide that the loss on 
rated accounts is to be covered in full up to an agreed per¬ 
centage of their capital rating; whereas on the off-rated ac¬ 
counts protection may be further restricted to only a certain 
percentage of the loss sustained, or possibly no protection 
afforded at all. 

Advantages of Credit Insurance . 

It is argued in favor of credit insurance that it gives the 
business man greater control over his costs, inasmuch as he 
need only add the premium, or cost of his insurance protection, 
to his normal or initial loss and other fixed costs to ascertain 
the exact cost of production, thus enabling him to compute his 
anticipated profits with a greater degree of certainty and 
accuracy. It is also contended that it tends to make the credit 
man more careful, and forces him to keep a closer watch on 
his accounts in order to make certain that he keeps well within 
the provisions of his policy. He must strictly observe the 
changes in the agency capital or credit rating of his customers, 
for the losses are adjusted on a basis of the latest information 
that was available at the time the goods were sold. Thus it is 
argued that instead of “taking the head off the credit man’s 
shoulders,” it serves as a guide to the credit man, and induces 
the exercise of care and caution on his part in the extension 
of credit. 


232 


INCIDENTAL CREDIT FACTORS 


A third argument advanced in its favor is that when the 
risk of excessive loss from bad debts is insured against, the 
house can take larger chances in extending credit and thus 
increase their volume of business. 

Objections to Credit Insurance 

Zimmerman in his article on “Credit Insurance” points out 
the disadvantages as follows: 

The value of credit insurance must depend largely on the 
credit man; its weak points appear plainly in the very presenta¬ 
tion of its advantages. It can be abused much more easily than 
well used. To a credit man the least inclined to shirk his re¬ 
sponsibility or take too long a chance it will prove fatal and 
against the best interests of his house. The very fact that he is 
dividing responsibility and putting the possible loss on someone 
else will make him more lenient in granting credits. The specific 
facts in regard to a customer which a credit man must watch to 
keep within the requirement of his bond are not extremely sig¬ 
nificant; the bookkeeper or office clerks can keep track of them. 

And a credit man carrying insurance may even disregard them 
altogether, figuring that he can take the extra chance even 
though his credit extensions are overstepping the stipulations 
of his bond. None of the arguments advanced as curbs on the 
caution of the credit man will stand examination. The credit 
man’s house will not be liable to hold a loss from bad debts 
against him if it is covered by insurance, provided that he can 
show that he has increased sales by taking this chance. Credit 
insurance companies themselves are compelled to confess that 
business men using their policies are apt to try to make money 
off them. That a high loss one year will raise their future normal 
loss and premium rate will not be likely to worry credit men. In 
short, the weak credit man is quite likely to be further weakened 
by carrying credit insurance and to substitute the security of 
his bond for good judgment. 

It is often questioned if credit insurance, as now conducted, 
has any value to the strong, able, watchful credit man, and 
whether it does not constitute a burden on him for the benefit 
of his weaker brother. Under the present insurance policy 
the credit man really does not make his own credits, and does 
not, therefore, make credits on a proper basis. On the one 


CREDIT INSURANCE 


233 


hand, if, hesitating to grant a doubtful credit, he does extend it 
because the case is covered by his bond, surely in this case it is 
not his judgment, but the protection of the bond, that makes 
the credit. On the other hand, in refusing against his own 
better personal judgment to grant credit because such extension 
will for some reason not come within his policy requirements, 
here again it is not he who is making the credit. 

If the normal loss of a large firm for a long period of years has 
averaged a certain percentage of its gross sales, it may wonder 
why it should pay out a considerable sum of money to be pro¬ 
tected against a loss above this normal, for it is extremely prob¬ 
able that, even though in some one year its losses will exceed 
this percentage, the average of the next decade will be no higher, 
and its premium will only be so much additional to be charged 
to the loss account. 

Credit insurance, as it is at present employed, protects the 
insured to a limited degree against unexpected credit losses. 
Whether or not business men should carry such insurance 
depends largely upon the answer to the following question: 
Can a comparatively equal degree of protection be obtained in 
any other manner and at a smaller expense? Carrying insur¬ 
ance of any kind is a considerable expense, and if this expense 
can be saved, over a period of years, the savings will cover 
or possibly more than cover the ordinary risks of the business. 

Proposed Plan of Shipment Insurance 

One of the greatest objections to present methods of credit 
insurance companies is the fact that the business man’s accounts 
are considered collectively and not individually, a characteristic 
which practically destroys its analogy to other kinds of insur¬ 
ance. Fire insurance companies, for example, do not divide 
property risks into certain classes and place each piece of prop¬ 
erty insured in one or the other of these classes, but investigates 
and appraises each risk separately. A step in this direction 
has for a long time been considered by the Credit Clearing 
House, probably the largest as well as one of the most efficient 
collection agencies and adjustment bureaus in the country, in 


234 


INCIDENTAL CREDIT FACTORS 


an effort to overcome the objection and meet the potential need 
for a different form of credit insurance. For years they have 
been operating a credit checking system, or interchange bureau, 
for textile lines exclusively, and as a result they have accumu¬ 
lated a very extensive and accurate mass of information on the 
strength of which they feel that they are in a position to 
undertake to guarantee shipments in this manner: 

A credit man receives an order concerning which he is in 
doubt. Instead of asking for reports or writing the customers 
for information, he will call the Credit Clearing House, and, 
based on the information they have in their files, they will tell 
him either to ship or not to ship. In event they tell him to 
ship and a loss on the shipment is incurred, they are obligated 
to make it good, and in every instance where they tell him not 
to ship, a report is to be immediately sent showing just why, 
in their opinion, the risk is dangerous. 

Advantages and Disadvantages 

Just as there are two sides to every story, there would seem 
to be both distinct advantages and disadvantages to such serv¬ 
ice. For instance, it would obviously mean much to a credit 
man to be able to obtain an immediate ruling on a doubtful 
order, as it would relieve him of the time and trouble of making 
the usual investigation and also enable him to act without 
delay. 

On the other hand, it is conceivable that the difference in 
the volume of business transacted by two competing houses 
might be largely due to the respective policies carried out by 
their credit managers, one possibly being extremely liberal and 
the other ultra-conservative. In other words, presented with 
the same information relative to a certain customer, the one 
would take a chance and ship the order, whereas the other 
would “play safe” and refuse to fill it. It is obvious what 
the result would be if the passing on such business is to be left 
to a practically disinterested third party, whose success and 


CREDIT INSURANCE 


235 


profit depends, not on the volume of business done by the 
insured, but only on the percentage of loss suffered. Are not 
large salaries paid to credit men and the heads of credit depart¬ 
ments for the very purpose of deciding such doubtful cases 
in the best interests of the house? And is not this service, in 
substance, an attempt to relieve them of the responsibility 
which their discretion, judgment, and experience should best 
enable them to assume? 

If such a service is found feasible and desirable, the Credit 
Clearing House is unquestionably well qualified to render it 
because of the very extensive data acquired through the opera¬ 
tion of their credit interchange bureau, and the supplemental 
information procured through their national collection agency. 
It is simply an advanced and specialized form of agency 
service and quite an innovation in credit work. Just what 
degree of success it will receive remains to be seen. 


CHAPTER XXI 

GRANTING OF EXTENSIONS 


Cardinal Principles 

If any cardinal rule or principle can be laid down as govern¬ 
ing the granting of extensions, it is that great conservatism 
should be practiced in granting additional time to delinquent 
debtors, and that promiscuous requests for additional time 
should be discouraged. The efficient credit man will always 
demand a good and sufficient cause and reason for the delay 
in payment before any extension is granted. In fact, he is 
placed on guard just as soon as a debtor has failed to pay 
his account when due, and it is only reasonable that he should 
want to know, not only the reason for the delay, but also the 
prospects for payment within the additional time requested 
before consenting to the extension and refraining from taking 
any radical action to protect himself. 

In the first place, a customer asks for an extension only 
when he is not in a position to settle his account—for some 
reason which may be either good or bad—and the credit man 
is hardly in a position to pass on the merit of his request until 
he knows why such a request is necessary. A merchant find¬ 
ing himself in this condition must seek accommodation or relief 
in one of two ways—he may borrow money to pay his bills, 
or obtain extensions of payment from his creditors. Being 
insolvent, for the time being at least, he would naturally expe¬ 
rience difficulty in negotiating a loan; so the latter alternative 
is the one usually , chosen. 

Preliminary Investigation 

Sooner or later every debtor, struggling in the throes of 
insolvency, will be compelled to ask for extensions to obtain 

236 


GRANTING OF EXTENSIONS 


237 


relief from the ever-increasing pressure of his creditors, and 
the past record of an active account will often “tell the story” 
without asking for any additional information from the debtor 
himself. In fact, the first step taken by an experienced credit 
man in handling such a request is to get the following data: 

Credit limit 
Amount outstanding 
How pay 
Bills overdue 

This is of so frequent occurrence that established houses have 
little slips, or forms, made up, which they can simply attach 
to the correspondence and pass over to the bookkeeper handling 
the account. 

It is the policy of many firms to have the bookkeeper note 
in red ink at the top of his ledger the credit line placed on each 
account. This enables him to supply a sort of collateral check 
on the shipments that are made; e.g., if in entering an invoice 
covering a shipment to A, amounting to $1,500, he notes that 
A’s credit line is only $500, the error on the part of the credit 
department in checking the order is immediately found. With¬ 
out this check of the bookkeeper the error would very likely 
pass unnoticed until the account became overdue and was sub¬ 
mitted to the credit department for collection. 

Under “How pay” the bookkeeper will not rate the cus¬ 
tomer as prompt, good, or bad—this being a prerogative of 
the credit man—but will list the corresponding charges and 
payments for several months previous. 

Practical Illustrations 

Let us assume, then, the investigation discloses the follow¬ 
ing facts: 

1. A has been trading with the firm for several years, and, 
while he has taken discount only intermittently, he has always 
paid his bills in a prompt and businesslike manner. At present 
his account shows his credit line full, with two bills past due— 


238 


INCIDENTAL CREDIT FACTORS 


one 15 days and the other 30 days. He is now requesting a 
30-day extension, within which he promises to settle the entire 
account. 

2. Six months ago B was discounting his bills, but it was 
only a short while before he discontinued taking his dis¬ 
count and paid his bills at maturity. Of late, however, he has 
been getting a little slow, taking overtime in several instances, 
and his account now shows his credit line full and several out¬ 
standing bills overdue. He is also asking for an extension of 
30 days within which he promises to make a payment on the 
account. 

When confronted with two such cases the experienced 
credit man would reason somewhat as follows: A certainly 
has a clean record; in fact, it is such as clearly to entitle him 
to consideration in his present position. He has probably over¬ 
bought and not found business as good as anticipated. Another 
30 days should prove sufficient for him to straighten out his 
finances, and he has promised to settle the entire account within 
that time. There is every reason to believe that he will fulfil 
his promise, or at least is honest in his expectation that he will. 

As to B it is obvious from his record that he is gradually 
going from bad to worse, and an extension under such circum¬ 
stances is not to be thought of; in fact, his request serves as a 
warning to “get out from under” as quickly as possible and 
before the inevitable fall comes. 

Having decided to grant A the accommodation requested, 
but to deny a similar favor to B, the next step for the credit 
man to consider is the proper manner in which to convey his 
decision to them. One might reasonably suppose that the only 
thing for him to do is to write both of them a pleasant letter— 
to A telling him that he will be granted his request, on his 
assurance to settle the account within 30 days, and to B telling 
him how much the credit man regrets having to refuse his 
request. Such simple procedure, however, would hardly be 
in keeping with the extreme conservatism advocated in this 
connection. 


GRANTING OF EXTENSIONS 


239 


Showing Leniency with an Account 

The tactful credit man will wish to take advantage of the 
opportunity to impress upon A the magnitude of the favor he 
is asking and to draw him out a little with a view to ascertain¬ 
ing the true reason for his temporary embarrassment. Hence 
some such letter as this would seem more likely: 

We have your favor of.and are rather 

surprised to learn that your affairs are in such shape as to neces¬ 
sitate your request for additional time in which to settle our 
account. 

It is strictly contrary to the general policy of this company 
to grant, or allow, additional time in payment of our bills, but 
we appreciate the very nice business with which you have been 
favoring us, and to show our appreciation, we are rather disposed 
to favor you in this instance, provided the cause of your present 
condition is such that another 30 days will suffice to remedy, 
and concerning which we should like to have additional infor¬ 
mation, so that we may give the matter our careful consideration. 

We shall, therefore, reserve our decision until we have heard 
further from you in this connection. 

Then, when advising him of the decision, the extension 
should be cheerfully granted, and the spirit of the letter such 
as to convey the feeling that it gives the credit man pleasure 
to be able to accommodate him: 

We have your favor of . in further 

reference to your account with us, and having carefully 
considered your reasons for ^requesting this extension, we are 
pleased to advise that it will be entirely satisfactory for you to 
extend payment of your account 30 days. 

We are very glad to be able to grant your request and trust 
another 30 days will bring about a decided improvement in your 
financial affairs. 

Closing an Account 

Since it has been decided to withdraw B’s credit line 
entirely, this would undoubtedly be a very inopportune time 
to advise him accordingly and some such letter as the following 
would seem tactful under the circumstances: 




240 


INCIDENTAL CREDIT FACTORS 


We have your favor of.requesting an 

extension of 30 days in payment of your account with us, and 
are very sorry to learn your affairs are in such shape as to make 
such a request necessary. 

It has for years been the policy of this company to decline 
to grant any extensions in the payment of our bills, except under 
very unusual circumstances, and while we appreciate the business 
with which you have favored us, and much as we would like to 
accommodate you by granting your request, in justice to our 
other customers, we cannot see any special reason for deviating 
from our general policy in this instance. • 

Furthermore, we feel that we have been very lenient with 
you in the past, and wish to call attention to the numerous 
occasions on which you have recently taken overtime on our 
bills. We simply cannot allow you to continue to take advantage 
of us in connection with our terms of payment, so unless we 
receive your positive assurance that our terms of payment will 
be strictly observed in the future, we shall consider it necessary 
to withdraw the line of credit placed on your account. 

Your account is now considerably past due, and under the 
circumstances, we shall have to insist upon an immediate 
settlement. 


Legal Aspects of Extensions 

By an “extension” is meant the granting of further time 
on the part of a creditor to a debtor in which to pay his 
account. 

It is a well-established rule of law that when a legal obli¬ 
gation already exists, a cumulative, or second, promise to 
perform it, unless based upon a new consideration, is a nullity. 
Such a promise adds nothing to or takes nothing from the 
original obligation, and being without consideration to support 
it, is not binding. 

Applying this principle of law to the facts presented in 
the ordinary request for an extension, it means that a mere 
agreement to give additional time, or to extend the date of 
payment, without any advantage coming to the creditor from 
the delay, does not bind the creditor because the debtor’s 
promise to pay is only cumulative, 



GRANTING OF EXTENSIONS 


241 


In other words, there must be some advantage accruing to 
the creditor in order to make the extension binding. However, 
the thing surrendered by the debtor may be of little value and 
the benefit to the creditor very slight; but if present, it con¬ 
stitutes an adequate consideration. 

When the Acceptance of a Note Is an Extension of Credit 

Where a bill or promissory note is given by a debtor in 
consideration of being granted an extension, by changing the 
nature of his indebtedness from an open book account to that 
of a promissory note (particularly if it is an interest-bearing 
note) the debtor is doing something he was in no wise obli¬ 
gated to do by the terms of the original agreement. This 
would, therefore, in the author’s opinion, constitute a valid 
consideration. 

The rule may, therefore, be laid down that the acceptance 
of a bill or note tendered by the debtor in consideration for 
the granting of an extension in the time of payment of an 
existing indebtedness suspends the right of action thereon until 
the maturity of the bill or note. And the law is clear that if in 
payment of a debt, the creditor is content to take a bill or note 
payable at a future date, he cannot legally commence an action 
on his original debt until default is made in the payment of 
the bill or note. 

As to whether or not the old claim or book account becomes 
merged in the note in such instances, thereby constituting what 
is legally termed a “novation,” is a debatable point of law. 
This much can be said, however; if the note or bill is accepted 
by the creditor in payment of the account, the effect would be 
to extinguish the original debt; whereas, if it was only taken 
as collateral security, it would not have that effect. In other 
words, the legal effect of the transaction would depend upon 
the intention of the parties. However, the weight of authority 
seems to favor the doctrine that nothing short of actual pay¬ 
ment, or the acceptance of a higher security, as, for example, 


242 


INCIDENTAL CREDIT FACTORS 


a note made or indorsed by a third party, will discharge the 
original claim. The courts are, however, united upon the rule 
that where a creditor accepts a bill or note in payment of a 
debt, the original term of credit is at least extended for the 
time specified in the bill or note. 

Effect of Fraud 

Where fraud, deceit, or undue influence enters into the 
transaction, the rule is different. And where a debtor, in order 
to bridge over a certain period within which he can dispose 
of his property, or safely remove himself beyond the juris¬ 
diction of the court, secures an extension of his credit by 
procuring the acceptance of his note maturing at a later date, 
with the intent thereby to defraud his creditors; or where the 
note or bill is given and accepted, when the debtor knows that 
it will not be paid; or the acceptance is procured through false 
representations; or by deceitfully withholding material facts 
that it was his duty to disclose; the creditor may at once 
disregard the entire transaction, return the note, and sue upon 
the original indebtedness. 


CHAPTER XXII 

TRADE ABUSES 


Definition 

There is unquestionably an element of truth in the saying, 
“There are tricks in all trades,” and while the professions are 
cursed with members who resort to unjustified means of accom¬ 
plishing their ends, we have a corresponding element in the 
commercial world who resort to unbusinesslike practices to 
increase their profits. But instead of being called “unprofes¬ 
sional conduct,” or “sharp practice,” as it is generally referred 
to professionally, such practices are known in the business 
world as “trade abuses.” 

Unearned Discount 

Perhaps the most perplexing problem of this nature with 
which the credit man has to contend is the taking of unearned 
discount—remitting less the discount after the discount period 
has expired—and in order to fully appreciate the nature of this 
abuse it is necessary to understand clearly just what “cash 
discount” is and the purpose for which it is offered. 

Cash discount is a premium (not interest) allowed by the 
seller of merchandise to the buyer for payment of an invoice 
within a specified period, depending in time and amount on 
the terms of sale. For example, terms of 30-1-10 mean the 
full amount of the invoice is due in 30 days but a deduction 
of 1 per cent from the gross amount will be allowed provided 
payment is made within 10 days. The amount of such allow¬ 
ance varies from per cent in 10 days to 10 per cent for cash 

« 

in 30 days. Being therefore a part of the terms of sale it is 
just as much a part of the contract as the price to be paid for 


243 


244 


INCIDENTAL CREDIT FACTORS 


the goods, and consequently a buyer has no greater right to 
deduct the discount after the discount period has elapsed than 
he nas to remit on a basis of 30 cents a gallon for oil which 
was purchased at 31 cents a gallon. 

Object of Cash Discount 

The chief object of the seller in offering cash discount is 
to promote prompt payment and thereby reduce the risk of loss 
from doubtful accounts. In actual practice, however, it is 
found that it is the good credit risk that will always take the 
discount, while the poorer risks will waive the privilege and 
permit the account to run to maturity. The theory is that 
he can afford to sell the buyer with a smaller return to himself, 
provided he can get hold of the money within a certain time 
and enjoy the use of it in operating his business between the 
expiration of the discount period and the maturity of the bill. 
Such being the object of cash discount, it therefore follows that 
the buyer not only has absolutely no right whatever to take 
the allowance after the specified time has expired, but by so 
doing he also defeats the very purpose for which it is offered. 

Here is, then, the situation with which we have to contend. 
We have a customer whose business is attractive and which 
we wish to retain, but he has taken unearned discount. Shall 
we demand the difference, small though it may be, as a matter 
of principle, or shall we overlook it for fear of offending the 
customer and losing his business? Theoretically, as has been 
pointed out, the practice is wrong and should never be over¬ 
looked or waived. But as a matter of business practice a 
liberal and flexible policy in dealing with this situation is 
necessary, because many houses, on account of keen compe¬ 
tition and their thirst for business, countenance such unfair 
practices and are responsible for the attitude prevalent among 
the trade that to dun Customers for such a small difference 
would be “treating ’em rough” and showing a lack of appre¬ 
ciation of their business, and that since such deductions are 


TRADE ABUSES 


245 

overlooked in some houses, the same attitude is to be reason¬ 
ably expected by buyers from all others. 

Various Phases of the Problem 

The problem has many phases, one of which has to do with 
the buyer who refuses to pay for goods before they have been 
received, and then remits less the discount. At first, this seems 
only reasonable; but was anything stipulated or implied in the 
terms of discount as to the delivery of the goods? By shipping 
him on open terms the seller has manifested his confidence in 
the buyer. So the buyer should reciprocate this confidence 
by believing that the seller will correct any errors that may 
later develop in filling his order, and should remit within the 
discount period if discount is to be taken, remembering it is 
always his privilege to await delivery and then remit the full 
amount at maturity. 

Another phase has to do with the antedating of checks. 
For example, the discount period has expired on the 10th day 
and a buyer remits less discount on the 13th day, dating his 
check the 10th. His defense that the check was made out on 
the 10th day and the delay therefore attributable to the mail 
service is groundless, for a bill is certainly not paid when a 
check is signed, and as the post mark is conclusive evidence as 
to date of mailing, it is quite evident that the discount has not 
been earned. 

Two Ways of Handling Violations 

Suppose a check for the bill less unearned discount is 
received and the seller does not intend to waive the difference. 
The question is: Which is the better policy to pursue—to return 
the check and request another drawn for the full amount at 
maturity—or to keep the check and ask for another covering 
the difference? Certainly a more serious intent to collect the 
difference is manifested by the first method, as in that case the 
buyer can do but one of two things, either return the check, 


INCIDENTAL CREDIT FACTORS 


246 

or pay the full amount at maturity. On the other hand, the 
second method often proves a long and tedious process. 

There are undoubtedly instances when it is prudent from 
a business standpoint not to make an issue of such discrepan¬ 
cies, and others when it is advisable to insist upon an adjust¬ 
ment even at the cost of losing the business, but in either case 
it is never wise to “nurse a grievance.” First consider the 
facts and decide the course to pursue, and then either demand 
an adjustment or overlook it entirely, once the matter has been 
brought to the buyer’s attention. Any vacillating or contro¬ 
versial attitude not only weakens the seller’s position but lowers 
the respect for his firm in the eyes of the debtor. 

The following letter is submitted as an example of a polite, 
non-offensive, yet effective way of bringing the matter of a 
first offense to the buyer’s attention: 

We have your favor of the 10th and wish to acknowledge 
receipt of your check for $298.85, tendered as in full settlement 
of our invoice of May 1, less the usual deduction for cash 
discount. 

The limit for discounting our bills, however, is 10 days, 
whereas your check was not mailed until... .days after the 
discount period had expired. So you are consequently not 
entitled to the benefit of this deduction. 

Cash discount is, as you are of course aware, offered for the 
sole purpose of encouraging prompt payments, so it is necessary 
for us to have a limit within which our bills may be discounted; 
and as our terms are 30 days net, you will readily realize that 
we are not justified in making this limit more than 10 days. 

We are perfectly willing in this instance to overlook the 
delay and accept your remittance as rendered, but we do not 
want our action in this particular instance to be considered as 
establishing a precedent for the future. 

Below is an example of a polite refusal to accept the check: 

We duly received your favor of the 10th in which you sent us 
your voucher check drawn for $298.85, which was tendered in 
payment of our invoice of May 21, less 1% cash discount. 

We wish to call your attention, however, to the fact that 


TRADE ABUSES 


247 


our terms of payment allow 1% discount only when a remittance 
is sent us within 10 days from the date of the charge, and as the 
remittance referred to was not sent us until.... days after the 
discount period had expired, you were not consequently entitled 
to the benefit of the cash discount deducted. 

We are therefore returning your check to you, with the request 
that you let us have a remittance for the full amount of the bill 
in question. 

Interest on Past-Due Accounts 

Where a customer is permitted to take overtime on his 
account, he is in fact using borrowed capital rightfully belong¬ 
ing to the seller, to finance his business, for the use of which 
he is paying nothing. In order to overcome this injustice many 
houses have adopted the policy of charging interest on past- 
due accounts. There is no question as to the legality of such 
procedure, but in view of the fact that such a policy is followed 
by but a minority of merchants, it is proper, if not necessary, 
that this fact should be stated on all orders, invoices, and 
statements, or notice should be brought to the attention of the 
customers that the rule will be enforced. 

The same principle should likewise apply to notes received 
from customers where an extension in time of payment has 
been granted. Such notes should always provide for the pay¬ 
ment of the legal rate of interest for the extended period. 

Shortage 

There was a time when claims of shortage in shipments 
were a source of great annoyance and considerable expense to 
manufacturers, but this has largely been overcome by precau¬ 
tions in the nature of checking, taken at both ends of transit, 
thus shifting the burden of responsibility to the carrier. 

Responsible houses now make it a practice to have every 
shipment checked in such a way as to enable them to submit 
an affidavit as to the contents and an effective way of guarding 
against unfair claims of this nature is to attach to each invoice 


INCIDENTAL CREDIT FACTORS 


248 

a copy of the shipping list showing the contents of the package 
or shipment and calling attention to the fact that the list has 
been checked by at least two persons whose names or initials 
are signed to it. Such procedure simply serves as notice to 
the consignee that the shipper is prepared to resist an unfair 
claim. In event, however, that a shortage is claimed, it is 
expected of the buyer that he, too, is prepared to substantiate 
his claim with a similar document. These affidavits are then 
submitted to the carrier as proof that the shortage occurred 
in transit. This policy has also served to put carriers on 
guard, and has resulted in a careful checking all along the line, 
and, consequently, a material reduction in the number of short¬ 
age claims. Claims for damage to goods in transit are handled 
in like manner. 

As between the parties to a sale, the terms of sale determine 
whether the burden of following up a shortage rests with the 
buyer or seller. If the goods were sold “freight prepaid,” the 
responsibility of the seller ceases when the goods are turned 
over to the carrier and a receipt, in the nature of a bill of 
lading, is obtained; if the goods were sold “delivered,” the 
responsibility of the seller continues until the shipment is actu¬ 
ally turned over to the buyer at destination. 

Such claims present a splendid opportunity for the seller 
to render a further and greatly appreciated service to custom¬ 
ers, and many of the larger manufacturers willingly assume 
the handling of such claims with the carrier on receiving the 
necessary data from the merchant. He may write to the buyer 
as follows: 

We are quite surprised to learn from your favor of the 

.that there was a shortage of 5 bbls. of soap chips in the 

shipment we consigned to you on.. as a 

reference to the bill of lading shows the shipment to have 
consisted of 50 rather than 45 bbls. 

Inasmuch as our goods are sold “freight prepaid” and not 
“delivered,” our actual responsibility ceases when we have 




TRADE ABUSES 


249 


delivered the goods to the railroad company and obtained a 
signed bill of lading from them, showing the goods to have been 
received in good order; but our interest in the matter continues, 
however, until we know the shipment has been received by the 
buyer and in accordance with the order placed with us. 

It is therefore the policy of our company to relieve our buyers 
of the trouble and annoyance of filing claims to cover such 
shortages, so we are enclosing an affidavit for you to execute 
covering the shortage in question, upon return of which we shall 
file your claim and follow the matter up closely until a satisfactory 
adjustment has been obtained. 

Checks Marked “Payment of Account in Full” 

Is a check given in payment and marked “In full of 
account” which does not as a matter of fact pay the entire 
account, payment in full; and is the payee who holds the 
check estopped from enforcing a claim for the uncovered bal¬ 
ance? The general rule is as follows: If the claim is liquidated 
and there is absolutely no question as to the amount due, a 
check for a lesser amount than the claim, even though marked 
“In full of account,” does not settle the account and the cred¬ 
itor may keep the check and sue for the balance. If, however, 
there is a dispute as to the amount of the claim and the same 
is not liquidated, a check sent “In full of account” amounts to 
an offer to settle the entire account for the amount specified in 
the check and the creditor must either return the check and sue 
for the amount claimed by him, or accept the check in full 
payment. 

Another phase of this question has to do with checks that 
are sent in after the discount period is passed, with the discount 
deducted, and are marked “In full of account.” Can such 
checks be properly deposited and claim be made for the amount 
of the discount? The answer is that they obviously fall under 
the above-mentioned rule, and claim can be made for the cash 
discount so deducted in cases where there is no dispute as to 
the terms. The practical effect of the matter is, however, that 
each single transaction is, in most instances of this character, 


250 


INCIDENTAL CREDIT FACTORS 


for a comparatively small sum for which it would be imprac¬ 
tical to sue because of the incidental expense. 1 

Defects in Remittances 

In the handling of collections, checks are frequently re¬ 
ceived containing a discrepancy between the amount specified 
in writing and the amount in figures. In such a case the 
credit man may either return the check for correction, or put 
an indorsement on the check guaranteeing it for whichever is 
the correct amount and deposit it for collection. 

A credit man will often find in the mail a check from a 
slow customer, which is unsigned. In order to avoid any fur¬ 
ther delay in payment, he may arrange either to deposit the 
check for collection with the understanding that it is to be 
signed by the maker when it is received by the bank on which 
it is drawn, or he may deposit it with a sight draft attached, 
with the understanding that it is to be forwarded to the maker’s 
bank for collection. 

Assuming a check to be returned marked “Not Sufficient 
Funds,” the credit man can possibly arrange to leave it with 
the bank on which it is drawn with an understanding that as 
soon as sufficient funds are deposited to cover the amount of 
the check, the bank will certify it and return it to the holder. 

Or, where the account lacks but a few dollars of covering 
the check, he may follow the plan of one resourceful credit 
man, and deposit to the credit of the maker of the check suf¬ 
ficient of his own money to bring the account up to the re¬ 
quired amount and then have the check certified. 

Market Declines 

Claims for market declines are confined almost exclusively 
to products sold on a fluctuating market and arise in this 
manner: A customer places an order with the house at a 
certain price and the goods are delivered accordingly. By the 


1 See Credit Men’s Manual of Commercial Laws, p. 216. 



TRADE ABUSES 


251 


time the invoice covering the shipment falls due the market 
price of the goods has declined, and he remits on a basis of 
the present price, claiming that he should be given the bene¬ 
fit of the decrease. 

There is of course no more justice in such a contention 
than there would be in the reverse situation, where on a rising 
market the manufacturer bills the customer at the advanced 
price rather than that at which the order was taken. The 
terms of sale are fixed when the business is booked and are not 
subject to change or alteration except by entering into a new 
agreement. 

There is but one ground on which such claims can be 
justified, and that is when the salesman in booking the busi¬ 
ness guarantees the price of the goods against any market 
decline under so-called “G.A.D.” contracts. In no other in¬ 
stance should such claims be allowed, and when a customer 
claims to be given such favors by other houses, he is simply 
branding himself as one who measures his commercial in¬ 
tegrity and his general business reputation in terms of dollars 
and cents. 

Returned Merchandise 

The return of merchandise on the ground that the “goods 
are not as represented” generally connotes a lack of foresight 
on the part of the buyer in anticipating a market for the goods, 
and, having made an unprofitable purchase, he seeks this 
means of disposing of the unsold portion. Practiced to any 
great extent it would work quite a hardship on the manu¬ 
facturers and also encourage promiscuous buying and careless 
selections on the part of the trade. So the policy of credit 
men should be to discourage it and refuse to relieve the mer¬ 
chant of such goods except for good and sufficient cause. One 
way in which this evil could be largely curtailed is through 
the general adoption of the trade acceptance (see Chap¬ 
ter XXV). 


INCIDENTAL CREDIT FACTORS 


252 

No Invoice 

One of the many ruses practiced in mitigation of delay in 
payment and quite annoying to a credit man is for a customer, 
after having had the account brought to his attention several 
times, to write or return the draft sent to him with a notation 
that he has not received the invoice. To combat this evil the 
credit system should provide for all invoices returned for lack 
of correct or complete address, or any other reason, to be re¬ 
ferred to the credit department for their information, and also 
to the bookkeeper handling the account, in order that he may 
also mark his records accordingly. There are several ad¬ 
vantages in so doing: (1) it serves as a check on the billing 
department; (2) it leads to proper correction being made in 
the bookkeeper’s records; and (3) it places the collector in a 
position to “come back” at the debtor in somewhat the fol¬ 
lowing manner : 

We have your favor of. (or, the bank 

has just returned the draft drawn to cover our charge of. 

amounting to.with a notation stating that you had 

no invoice covering the shipment) in reference to your account 
with us, stating you were unable to locate the invoice covering 
our charge of.amounting to. 

We are not only at a loss to understand why the matter was 
not previously brought to our attention, but furthermore cannot 
account for your failure to receive an invoice covering the 
shipment, as our goods are invariably billed the day shipment 
is made and we have no record whatever of the invoice in 
question having been returned. 

However, we gladly hand you a copy of the billing, and as 
the charge is now considerably past due, we trust arrangements 
will be made to favor us with an immediate remittance to cover. 

Cancellation of Orders 

There are two possibilities to be discussed in connection 
with canceled orders: 

1. Cancellation of orders involving no change in the price 
of the goods. 







TRADE ABUSES 


253 


2 . Cancellation of orders where there has been a decline 
in the price of the goods since the order was placed 
and before delivery is made. 

1. In such instances a due regard for the truth and a knowl¬ 
edge of the real situation compels the admission that an 
“order,” so called, according to the custom of manufacturers 
almost universally prevailing, is nothing more than an option 
in favor of the buyer. It is cancelable by custom in event 
the buyer sees fit to cancel, because few sellers are willing to 
sue the buyer upon the order. Furthermore, the seller often¬ 
times has orders on his books received through his salesmen 
on which the buyer has been given to understand that he does 
not have to take the goods if he does not want them. Such 
an order can easily be revoked by the buyer in case he deems it 
to his advantage. 

In such a situation the seller is compelled either to comply 
with the buyer’s wishes and cancel the order, or refuse to do 
so and either force delivery of the goods, or sue for the dam¬ 
age or loss of profit caused by the refusal to accept the goods. 
In nine cases out of ten, however, the seller will choose the 
former alternative as the wiser course to pursue and trust to 
future business to offset his loss in this instance. In some 
lines of business a weakness has developed under the pressure 
of competition in the matter of assenting to cancellations 
rather than to risk incurring the displeasure of customers. 

This is, of course, an unfortunate situation, for which both 
the manufacturer and the merchant are to blame, the former 
for countenancing such a practice, or for permitting his sales¬ 
men to place him in such a position that he is forced to 
countenance it, and the latter because of his manifest lack of 
respect for the moral, if not strictly legal, obligation involved. 

Like other trade abuses that of canceling orders will also 
be eradicated in time through co-operative competition between 
the larger houses, and through a general elevation of the stand¬ 
ards of doing business among the trade. 


254 


INCIDENTAL CREDIT FACTORS 


2. Suppose A, a butterine manufacturer, using a large 
quantity of cottonseed oil in the preparation of his product, 
enters into a contract with B in February for his June oil 
requirements, calling for 3 cars of oil, June delivery, at 85 
cents a gallon. Between February and June the price of oil 
has dropped from 85 cents to 72 cents a gallon. B writes A 
on June 1 asking for shipping instructions on the 3 cars of 
oil which he contracted for in February at 85 cents a gallon, 
and A writes a very pleasant letter in reply in which he states 
his business has not been as good as he expected and he finds 
he has enough oil in stock to carry him through the month and 
consequently is not in a position to accept delivery of the 3 
cars. What is B going to do about it? B has a profit of 13 
cents a gallon on the 3 cars of oil but he cannot ship the oil, 
for A has told him that he does not intend to take it. The 
manner in which contracts of this nature, based on a fluctuat¬ 
ing market, are handled is this. The 3 cars of oil, theoretically 
at least, have been set aside waiting shipping instructions from 
A, and when he refuses to accept delivery, the oil is sold on the 
open market at the prevailing market price (72 cents a gallon) 
and he is billed with the market difference of 13 cents a gallon, 
for which amount he can be held legally liable under the com 
tract. 

Unjust Claims 

The reader should not be misled to think that each and 
every case presented represents a deliberate attempt on the 
part of a customer to take an unjust advantage of his cred¬ 
itor, for while this is frequently true, there are also instances 
when a customer is likewise convinced that the house is trying 
to take an unjust advantage of him, and in such instances it is 
the duty of the credit man to handle such claims in such a way 
as not to give offense to the trade. 

Collectively, these trade abuses may be said to constitute 
the seamy side of the credit man’s work, and it is in the han- 


TRADE ABUSES 


255 


dling of such claims that the credit man is afforded an oppor¬ 
tunity either to display tact and diplomacy by pleasantly and 
inoffensively pointing out and successfully maintaining his side 
of the controversy, or, through incapacity to cope with the 
problems presented, to manifest an antagonistic spirit which 
eventually proves costly to the house because of a loss of 
business. 

Correction of Abuses 

The correction of these various trade abuses rests primarily 
with the larger and more responsible houses whose brands and 
trade are well established, enabling them to assume and main¬ 
tain an independent stand by refusing to tolerate such prac¬ 
tices, and the most that can reasonably be expected of the 
smaller competitors is their co-operation in educating the trade 
to a realization of the injurious effect such practices have on 
both their business standing and credit responsibility so as to 
raise customers’ standards of doing business. 

The object should be to impress upon the offenders the 
true value and care that should be placed upon an established 
line of credit. They should be made to realize that their credit 
standing is a part of the character of their business, and that 
it is something which they can hardly afford to jeopardize by 
practicing any such abuses in the conduct of their business. 

And finally the cardinal rule or principle that has been 
established as a guidance in the handling of all forms of trade 
abuses is: “Hold the customer and his good-will if possible, 
and yet protect the firm from unbusinesslike practices.” 





PART V 


LEGAL RIGHTS AND REMEDIES OF 
MERCANTILE CREDITORS 





CHAPTER XXIII 

EFFECTING THE COLLECTION 

Prompt Collections and Turnover 

Prompt, or, as they are oftentimes referred to, “close” 
collections, constitute a vital feature of every business, be¬ 
cause the business profits are largely dependent upon the num¬ 
ber of times a merchant can turn over his invested capital. To 
illustrate this fact, let us assume a merchant doing business 
with a capital amounting to $100,000. The relationship of his 
turnover and gross profits may be shown as follows: 

$100,000 turned over twice a year at 10 per cent yields a 
gross profit of $20,000 a year. 

$100,000 turned over three times a year at 9 per cent 
yields a gross profit of $27,000 a year. 

$100,000 turned over four times a year at 8 per cent yields 
a gross profit of $32,000 a year. 

In other words, by diminishing his percentage of profit, 
and thereby enabling him to increase his capital turnover, one 
merchant can derive a greater profit from his business than 
another who insists upon realizing a larger percentage of profit 
on his sales and thereby restricts his capital turnover. 

The number of times a merchant can turn over his work¬ 
ing capital depends primarily on two equally important fac¬ 
tors : 

1. The rapidity with which he can market his goods. 

2. The rapidity with which he collects the money in pay¬ 

ment for the goods sold. 

The first is purely a matter of salesmanship with which we 
are not directly concerned. The second depends largely, if 


259 


26 o 


RIGHTS AND REMEDIES OF CREDITORS 


not entirely, upon the efficiency of the credit department in 
effecting the prompt payment for goods sold. 

Other Consequences of Slow Collections 

Although the close relation that exists between collections 
and the capital turnover may be said to constitute the most 
important reason for prompt collections, there are serious 
consequences of another nature which result from looseness 
or laxity in following up collections. These are as follows: 

1. Slow collections have a very harmful influence on the 
volume of sales because, generally speaking, a debtor whose 
account is overdue will be tempted to patronize a competitor 
rather than incur the possible embarrassment of having his 
order either refused or held up until the back bills have been 
paid. 

2. Prompt collections prevent the running up of a large 
overdue account and thus enables a concern to satisfy a greater 
need for their goods on a limited line of credit than is possible 
where the account is allowed to remain open after maturity. 

To illustrate this point, let us assume, first, that a mer¬ 
chant to whom we have extended a $1,000 line of credit, and 
are selling goods on terms 30-2-10, discounts our bills as 
follows: 

Sale $1,000 goods on 1st of month 


Paid 

980 

U 

n 

10th “ 

u 

Sale 

1,000 

a 

u 

nth “ 

it 

Paid 

980 

u 

it 

21st “ 

it 

Sale 1,000 

u 

a 

22nd “ 

a 


At this rate of payment sales could amount to $3,000 a 
month, or $36,000 a year. 

Next, let us assume that he pays his bills promptly at 
maturity: 

Sale $1,000 goods on 1st of month 
Paid 1,000 “ “ 31st “ “ 

On this basis sales could amount to only $1,000 a month, 
or $12,000 a year. 


EFFECTING THE COLLECTION 


261 

Finally, let us assume that he is allowed to take 60 days 
in which to pay: 

Sale $ 1,000 goods on 1st of month 
Paid 1,000 at end of following month 

Here sales could amount to but $6,000 a year. 

3 . Although it must be anything but pleasant for a debtor 
to be harassed by one’s creditors, still his respect is commanded 
by prompt and efficient collection methods. Most debtors 
respect a house that watches its accounts closely, and the natu¬ 
ral tendency is for them to pay the accounts of such a house 
more readily than those of a house which is known to be lax 
in following up its collections. 

Following the Collection 

Under this heading we are going to follow and discuss, 
first, the collection of an account from the time it falls due 
(after maturity an account automatically becomes a collection) 
to the point when it is placed in the hands of an attorney; and 
on through the levying of an execution on the debtor’s prop¬ 
erty, which represents the culmination of the creditor’s ef¬ 
forts, for if the debtor has sufficient property over and above 
the exemption the law allows him, to satisfy the claim, it will 
be attached and sold by a representative of the court, whereas 
if he has nothing over and above the exemption, the claim is 
returned as worthless (nolle bonne) and considered a “loss 
account.” 

The primary object of the collector is not simply “to get 
the money.” What is often of even greater importance is to 
retain the debtor as a customer.and hold his business, for 
obviously it is poor policy to hazard the loss of business ag¬ 
gregating $800 a month in the collection of a $300 account. 
The collector is consequently ever confronted with the 
dilemma—how to push a man for money without saying any¬ 
thing or taking any action which will offend him to such an 
extent that he will discontinue his custom. While at first the 


262 


RIGHTS AND REMEDIES OF CREDITORS 


two ends seem quite inconsistent, the dilemma not only can 
be solved but is being solved by efficient credit departments. 

Stages in the Collection Process 

In the first place, although there are few established rules 
to be followed in handling collections, each case presenting its 
individual problem, there are nevertheless certain well-defined 
stages through which the collection of an account may pass: 

1. Stage of notification, in which the debtor is notified 

that the account is due, generally by a typewritten 
statement of the account, timed to arrive the day the 
account falls due. 

2. Stage of reminder, in which the account is again brought 

to the debtor’s attention by means of a letter attribut¬ 
ing the delay in payment to some oversight. 

3. Stage of discussion, in which it is assumed that there is 

some special reason for the delay and the creditor not 
only wishes to ascertain the cause but also to impress 
upon the customer that the seller is not justified in 
allowing additional time on his bills. 

4. Stage of necessity, in which the creditor refuses to per¬ 

mit the account to run any longer and states his 
intention to adopt more radical measures in event it 
is not paid immediately. 

5. Stage of compulsion, where the account is placed with 

an attorney or collection agency to force payment. 

It is not meant by the foregoing that the collection of every 
account passes through each and every one of these stages. 
The circumstances may, for example, be such as to justify 
placing an account in the attorney’s hands without any discus¬ 
sion whatever as to the reason for the delay in settlement, but 
they represent all the possible steps which may be taken by the 
collector. The degree of aggressiveness with which the debtor 
should be approached will depend upon (1) the nature of the 
account, (2) the value of the business, and (3) the length of 
time he has been trading with the merchant. Thus a knowledge 


EFFECTING THE COLLECTION 


263 

of his credit standing, or a history of the account, so to speak, 
is absolutely essential to the intelligent handling of the col¬ 
lection. 

Throughout the first three stages the tenor of the cor¬ 
respondence is not only that he should pay but that he also 
intends to pay. In other words, the presumption is in favor 
of the debtor in much the same spirit as “a man is legally pre¬ 
sumed to be innocent until proven guilty.” Once convinced, 
however, that he does not intend to pay until compelled to, the 
collector has arrived at the fourth stage when “diplomatic 
relations are severed,” so to speak, and the attitude assumed 
by him in subsequent correspondence is that the debtor must 
pay, as shown first by the collector’s intention to adopt more 
radical measures and finally by threatening to place the ac¬ 
count in the attorney’s hands. 

Manner in Which the Transition Is Accomplished 

In the following discussion concrete examples of letters 
will be used to illustrate the spirit in which the transition from 
one stage to another should be accomplished in the collection 
of an account. 

1. Notification. This generally consists of a typewrit¬ 
ten statement, timed to arrive the day the account falls due, and 
serving to bring the account to the debtor’s attention in event 
it has been overlooked. The process is mechanical and the 
notice is almost always sent out by the bookkeeper handling 
the account. 

2. Reminder. There being nothing distinctive or per¬ 
sonal about a typewritten statement to command special recog¬ 
nition, the account is next brought to the debtor’s attention 
by means of a short letter courteously referring him to the 
account and attributing the delay to some oversight: 

We notice upon referring to your account with us that we 
have not as yet been favored with a remittance in settlement 
of our invoice of.- amounting to.. 




264 


RIGHTS AND REMEDIES OF CREDITORS 


and attributing the delay to some oversight in your office, we 
deemed it advisable to bring the matter to your attention. 

We recently sent you a statement calling attention to our 

invoice of .amounting to.but we 

do not find that we have as yet been favored with a remittance 
to cover. 

While we have no doubt that the matter has simply been 
overlooked, the charge is now somewhat past due, so we therefore 
trust the account will be placed in line for early payment. 

3. Discussion. The account having been brought to the 
debtor’s attention several times before, it can be safely pre¬ 
sumed that the delay in payment is not due to an oversight, 
and there must be some other reason for it. Either he is 
purposely delaying payment to gain additional time, or he is 
not in a position to pay. So a longer letter is used to impress 
upon him the fact that the collector is not justified in allowing 
additional time on his bills and endeavoring to elicit a response 
from him in explanation of the delay as a basis for further 
action: 

On referring to your account with us we find that we are 
still without a remittance in settlement of our invoice of 

. amounting to . although the 

matter has been brought to your attention on several occasions, 
and as we have heard nothing from you in this connection, we 
are consequently at a loss to understand the delay in payment. 

Inasmuch as the price of our products is based on our regular 
terms of payment, which as you know are limited to strictly 
.... days net, we are not justified in allowing additional 
time on our bills, and as the charge in question is now .... 
days past due, we must ask that the matter be given proper 
attention. 


We wrote you on.in connection with 

your account with us, calling attention to our invoice of 
. amounting to . but we cannot 


find that you have either complied with our request for a 
remittance to cover, or written us in explanation of the delay in 
settlement. 











EFFECTING THE COLLECTION 


265 


Our terms of payment on . are strictly . 

days net and the conditions under which this product is sold 
do not justify allowing additional time on our bills. 

The charge referred to is now. days past due, so we 

therefore wish to again request that the matter be given proper 
attention and we trust arrangements will be made to favor us 
with a prompt remittance to cover. 

Some firms make a practice of injecting a little sales talk 
into their correspondence in the first three stages of collection 
as suggestive of the value of continuing their pleasant business 
relations, and by way of anticipating an early settlement and 
further business. There is only one objection to this. It 
undoubtedly weakens the appeal by dividing the recipient’s 
attention. But the appeal up to and including the third stage 
is precatory rather than mandatory. So perhaps this is not 
such a serious objection after all. 

4. Necessity. Once convinced that it is the intention 
of the debtor to delay payment as long as possible, no time 
should be lost in impressing upon him the fact that he not 
only should, but must pay: 

We wrote you on . and again under 

date of . calling attention to our open 

charge of.amounting to.and 

requested that the matter be given proper attention, but we 
cannot find that a remittance for this amount has been received. 

As we have heard nothing from you in this connection, we are 
not only at a loss to understand the situation but have about 
come to the conclusion that the matter is one requiring more 
radical collection measures. 

While we dislike very much to take any action that would 
necessarily cause you annoyance or embrarassment, we feel that 
we have been very liberal with you in this connection, as the 
charge is now over.days past due. 

We must, thefore, insist upon the account being given 
immediate attention, for we wish to state quite frankly that 
unless a remittance in full settlement is received by return 
mail, we shall consider it necessary to adopt other collection 
measures for the proper protection of our interests. 











266 


RIGHTS AND REMEDIES OF CREDITORS 


Although the matter has been brought to your attention on 
no less than .... occasions we find we are still without a 

remittance in settlement of our invoice of. 

amounting to.and as we have not been favored with 

even the courtesy of a reply to our correspondence in this 
connection, giving us any explanation as to the delay in pay¬ 
ment, we have about come to the conclusion that the matter is 
one requiring the further attention of our attorneys. 

While we dislike very much having to write you in this 
manner, you must appreciate that we have been very considerate 

with you, as the charge referred to is now over .days 

past due. 

We therefore feel constrained to state, and we must also ask 
you to consider this final, that unless a remittance of the full 
amount involved is received by return mail, it is our intention 
to place the account in the hands of our attorneys. 

5. Compulsion. This brings us to the final stage in the 
collection correspondence, and once the account is referred to 
an attorney the collector no longer deals direct with the debtor. 
But if the amount involved is quite large and the account one 
in which you are particularly interested, it is oftentimes a good 
policy to advise the debtor of the action being taken and thus 
afford him a final opportunity to effect a direct settlement: 

We are sorry to find that you have not complied with our 

final request for a remittance of.in settlement of our 

invoice of., so we are accordingly placing 

the account in the hands of our attorneys today with instructions 
to take any action they may deem most expedient to the proper 
protection of our interests. 

Although we feel quite justified in taking such action, we 
would at the same time greatly prefer effecting an amicable 
adjustment of the amount involved. So if you will let us have 
a remittance in full settlement by return mail, we will gladly 
instruct our attorneys to return the claim without taking any 
further action. 

The adoption of legal measures with a view to forcing 
payment necessarily has a very injurious effect on a concern’s 
business standing, so for your own good we hope you will take 
advantage of this final opportunity to adjust the account with 
us direct. 







EFFECTING THE COLLECTION 


267 

Varying Degrees of Strength in the Tenor of the Appeal 

That the collector is given a wide latitude in voicing his 
appeal for payment may be satisfactorily illustrated by means 
of a few well-chosen words or phrases characteristic of the 
different degrees of strength that may be manifested in the 
tenor of his correspondence: 

1. “Merely wish to bring the matter to your attention.” 

2. “Wish to again call attention to the fact that our invoice 

of.has not been paid and ask that the mat¬ 

ter to be given proper attention.” (Note that no 
direct request for payment has as yet been made.) 

3. Ask for an “early” remittance to cover. 

4. Ask for a “prompt” remittance to cover. 

5. Insist upon an “immediate” remittance to cover. 

6. Insist upon a “remittance by return mail.” 

7. “Unless a remittance is received by return mail, we 

shall feel compelled to adopt other collection mea¬ 
sures.” 

8. “Unless a remittance is received by return mail, we 

shall feel compelled to adopt more radical, more 
stringent, or more drastic collection measures for the 
proper protection of our interests.” 

9. Threaten to place the account in the hands of an at¬ 

torney. 

Characteristics of a Successful Collection System 

It might be well to point out a few characteristics which 
may be considered essential to every successful collection 
system: 

1. Your correspondence must always, even in the final stages, 
be courteous and dignified for the prestige of your house, as 
adhering to high standards in all its methods from the time 
the sale is made to the time of its liquidation, no matter what 
the circumstances which may arise during that period, must 
be upheld and respected. Hard lines or roughshod methods 
will have a lesser force for good than mildness and clemency. 



268 


RIGHTS AND REMEDIES OF CREDITORS 


The cheapest thing in the world is courtesy, and it brings 
a larger volume of profit than any other factor in merchandis¬ 
ing. Some business men think that this applies only to the 
salesman who comes in personal touch with the customer, but 
this is not the case. Instances are numerous where a little 
courtesy shown in the tone of a letter has made a good cus¬ 
tomer. Cases are even more numerous where a discourteous 
letter has resulted in the loss of profitable business. It is 
utterly impossible to avoid entirely disagreements with cus¬ 
tomers, but a disagreement properly and courteously handled 
does not necessarily mean the loss of that customer’s business. 
But if it is not handled properly, not only is the customer lost, 
but he is aggrieved and is very likely to spread broadcast that 
the firm is not treating its customers fairly. A reputation of 
that kind will naturally make it more difficult for salesmen to 
get business. In order to avoid such a reputation, it is not 
necessary to be weak-kneed and allow every claim made by a 
customer. Courtesy and tact are a necessary part of successful 
collection correspondence. 

2. It is neither necessary nor good business policy to offer 
an excuse for requesting payment, for you are not in the posi¬ 
tion of one asking a favor, and it obviously reflects on your 
financial strength to show an urgent need of funds. In fact, 
the credit man should avoid most diplomatically any semblance 
of timidity in requesting payment. 

3. To be efficient, the collection system must be prompt 
and flexible. By being prompt in the collection of your ac¬ 
counts you show the debtor that his account is being carefully 
watched and such efficiency, while sometimes annoying, never 
fails to command respect. Furthermore, prompt and close col¬ 
lections keep the finances of your firm in a more healthy con¬ 
dition, and reduce the amount of working capital necessary 
to run the business. 

4. The system must also be susceptible to variation ac¬ 
cording to the nature of the accounts, as the severity with 


EFFECTING THE COLLECTION 


269 

which payment is requested is a matter of discretion and judg¬ 
ment of the correspondent, depending on the responsibility of 
the debtor, the value of the business, and the length of time 
he has been trading with you. 

A discussion of the draft in this connection has been pur¬ 
posely omitted for the reason that drafts are used differently 
by different concerns and the policy also varies with the various 
lines of business. Some firms make a practice of drawing on 
their customers 10 days after maturity, whereas others reserve 
this as a last resort prior to placing the account in the attorney’s 
hands. 

Dunning by Wire 

There are no legal restrictions which forbid the dunning of 
a debtor by telegraph, provided proper precaution is taken in 
the wording of the wire, i.e., a mere inquiry as to when a re¬ 
mittance may be expected. Any words, however, tending to 
convey the impression or inference that the debtor is a fraud, 
or a cheat, or that he unnecessarily or without cause delays the 
payment of his accounts might subject the sender to an action 
for libel. 


CHAPTER XXIV 

LEGAL PROCESS 


Credit Men and the Attorney 

A well-known writer on the subject once said: 

The grievance of the credit man against the lawyer is that 
he won’t work for nothing, and the grievance of the lawyer 
against the credit man is that he expects something which 
may save him thousands, and which is something of the lawyer’s 
stock in trade, for nothing. The credit man usually knows little 
about law, and the lawyer little or nothing about business, and 
when oil and water mix, we may expect a satisfactory result 
from two such forces. 

There seems to be a more or less common impression 
among credit men that something mysterious takes place after 
an account is turned over to an attorney, which is beyond the 
comprehension of anyone but an attorney, and the lack of 
knowledge on the part of many credit men as to just what does 
transpire in the subsequent proceedings is not only surprising 
but a great mistake on their part, because there is absolutely 
no reason why anyone of sufficient intelligence to handle col¬ 
lections should not be just as familiar with the process of forc¬ 
ing a settlement as an attorney. The usual procedure to be 
complied with involves very little law, and practically no legal 
reasoning, and for the most part constitutes a mere matter of 
formal procedure. 

It is a mistake for a credit man to assume that in turning 
an account over to an attorney he is through with it entirely, 
and thus shift over to the attorney the responsibility of decid¬ 
ing what action is advisable. In other words, it is unreason¬ 
able to expect a lawyer to act as credit man, and the most that 


270 


LEGAL PROCESS 


271 


can reasonably be expected of him is information and advice 
as to the credit man’s legal rights coupled with the desire and 
capacity to carry out his instructions. There are times when 
a credit man must have the assistance of an attorney, and the 
attorney in handling such business is, in turn, dependent upon 
the credit man for his information and instructions, simply 
because the credit man is more familiar with the debtor’s 
affairs. So in order to be productive of the best results, the 
relation between the two should be based on the co-operative 
principle—let each attend to the part he can handle to greatest 
advantage, and let the credit man never lose sight of the fact 
that he can reasonably expect attorney services only com¬ 
mensurate with the fee the attorney is to receive for such 
service. 

Law Lists of Bonded Attorneys 

In most states there are attorneys who make a specialty of 
handling the collection of commercial accounts and whose 
names are to be found in one of the numerous law lists, or 
“Directories of Bonded Attorneys,’’ published by the various 
agencies throughout the country and at all times available to 
credit men. 

The collection fees for handling such claims are usually 
fixed and published in the directory, together with a guaranty 
of the publisher of the list insuring the prompt payment to the 
creditor of all money collected by any attorney listed in their 
directory, provided the prescribed notice is given as to when 
and to whom the claim is being sent. The only objectionable 
feature to such service as contrasted with that of the various 
forwarding agencies, e.g., the Credit Clearing House and 
others, is that it does not relieve the creditor of the burden of 
following up the work of the attorney to whom the claim is 
entrusted in order to satisfy himself that the account is 
receiving the attention which it requires in order to be properly 
handled. 


RIGHTS AND REMEDIES OF CREDITORS 


272 

Forcing a Settlement 

Once an account has been placed in the hands of an at¬ 
torney, all correspondence received from the debtor should be 
referred to him, as from this time on the attorney should be 
considered in full charge of the matter. Suppose, however, 
that, after advising the debtor that you have placed the ac¬ 
count in the attorney’s hands with instructions to force a set¬ 
tlement, he sends you a check for the full amount. Should 
you keep the check or refer it to the attorney? If suit has 
been filed the check should not be accepted, because it costs 
money to sue a man and the court costs which have been ad¬ 
vanced will eventually have to be paid by the debtor in addi¬ 
tion to the full amount of the account. By accepting the check 
under such circumstances you thereby assume the court costs. 
If, however, suit has not been filed, there is no reason why 
the check should not be accepted without referring it to the 
attorney, but never fail to advise the attorney accordingly in 
order to save him the embarrassment of attempting to force a 
settlement of an account which has been paid. 

Demand for Settlement 

Let us follow the process of collection from the time the 
account is received in the attorney’s office. 

Generally, the first thing he does is to advise the debtor, 
either by letter or through some local representative, that he 
has received the claim for collection, and to demand an 
immediate settlement on behalf of his clients. 

Investigation 

Assuming such a demand to be ineffective, the next step is 
to ascertain the true financial responsibility of the debtor in 
order to determine whether, in event suit is brought and a 
judgment obtained, the debtor would be good for the amount 
involved under an execution. If the prospects disclosed by 
the investigation seem doubtful, suit is postponed for the pres- 


LEGAL PROCESS 


273 


ent—nothing is to be gained by throwing good money after 
bad—and dunning measures, such as the drawing of drafts, 
threats of suit, bankruptcy procedure, and the like, continued. 

If, however, the prospects of forcing a settlement appear 
favorable, suit is entered in the proper court, and the usual 
form of procedure thereafter in the prosecution of such a case 
in court is briefly as follows: 

1. Bringing of the case and the parties into court. 

2. Framing of an issue. 

3. Hearing or trial. 

4. Judgment. 

5. Appeal. 

6. Execution. 

7. The return. 


Suit 

The word “suit” is incorrectly, although quite commonly, 
used to describe and characterize the legal procedure of a 
creditor to enforce the payment of his claim. The proper 
phrase as used among lawyers is “an action at law,” the dis¬ 
tinction being that the word “suit” is strictly applicable to a 
proceeding in equity as distinguished from an action at law. 

Civil actions, such as those brought by a creditor against 
a debtor in the prosecution of his rights growing out of the 
sale of merchandise, are commenced by filing in the proper 
court (depending on the jurisdiction and size of the claim) a 
petition for judgment, on a form which in some states is very 
appropriately termed a “statement of claim” (Form 14) 
wherein the substance of the claim is set forth under oath in 
proper technical and legal form. 

Where the claim is to be sued upon in a distant city the 
usual procedure is for the creditor, instead of certifying such 
a statement of claim, drawn up by his local attorney, to exe¬ 
cute an “affidavit in proof of claim” (Form 15), which he 
then forwards to his attorney located in the city of the debtor. 


274 


RIGHTS AND REMEDIES OF CREDITORS 


In the Municipal 


The State of Ohio 
Hamilton County ss. 

City of Cincinnati 

The Crocker & Bramble Distributing Co. \ P1 • , 
a corporation under the laws of Ohio / 


Court of Cincinnati 


vs. 

Mary Volmer, 

doing business as “Volmer’s Home Bakery,” 
located at No. 1492 Montgomery Road, 
Cincinnati, Ohio 


Defendant 


No. 

Claim for $92.20 


STATEMENT OF CLAIM 

Plaintiff’s claim is upon an account, a copy of which with all credits thereon 
is as follows: 


1922 

Oct. 27, 

Lard Compound 

$ 7-75 

Nov. 2, 

u 

15 50 

“ 6, 

a 

7-75 

“ 13 , 

n 

15-50 

“ 29, 

n 

15-50 

Dec. 6, 

a 

15-50 

“ 13 , 

a 

15-50 


Credit: 

Less cash discount not deducted 


$93.00 

.80 


Balance $92.20 

There is due plaintiff from defendant upon said account the sum of ninety-two 
and 20/100 dollars ($92.20), payment of which has been demanded but refused. 
Wherefore: Plaintiff prays for judgment against said defendant for $92.20 
and for costs herein expended. 

S. Farrar Long 
A ttorney for Plaintiff 

Gwynn Building, Cincinnati, Ohio 
Business Address 

The State of Ohio . 

Hamilton County 1 ss. 

City of Cincinnati J 

A. R. Sheffield, being first duly sworn, says 

That he is Secretary of The Crocker & Bramble Distributing Co., plaintiff 
in the above entitled cause and that the facts set forth in the foregoing state¬ 
ment are true. 

A. R. Sheffield 

Subscribed and sworn to before me this 17th day of February, 19_ 

Guy B. Foster 

Notary Public —Hamilton County, Ohio 
My commission expires Oct. 23rd, 19__ 

Form 14. Statement of Claim 










LEGAL PROCESS 


275 


AFFIDAVIT IN PROOF OF CLAIM 

State of Ohio .... Hamilton .... County, ss. 

The undersigned. A. R. Sheffield .being first duly 

sworn, on oath states that he is 1 . Secretary of The Crocker & Bramble 

Distributing Co.—a corporation organized and doing business under the laws 

of the State of Ohio .the owner.. of the claim against. Mary 

Volmer, doing business as “ Volmer's Home Bakery ” at 1492 Montgomery 

Road, Cincinnati, Ohio .hereto attached and made part hereof; that 

the same and every item thereof is lawful and justly due; that the con¬ 
sideration therefor is 2 . goods and merchandise sold and delivered on 

open account by said claimant to said debtor at their special request, as per 
statement attached .that there is now due and unpaid on said claim 

the sum of. ninety-two and . 

20 

100 Dollars, ($92.20) with interest thereon at the rate of .... per cent, 
per annum. 

. from the ... .13.... day of .... January . . .., 

192___; that there are no payments on said claim in the way of dis¬ 

counts or otherwise; that there are no set offs nor counter-claims whatever 

against the same 3 . 

that there is no usury therein; that said owner has.no collateral, 

personal, or other security whatever for the same. 

(Affiant). A. R. Sheffield . 

Sworn to before me and subscribed in my presence this ... .17.... day 
of .... February.. .., 19 2 - 


(seal.) . Guy B. Foster . 

.. . Notary Public—Hamilton County, Ohio. .. 

Affidavit..-.. cents. Paid by..-.. 

.... My commission expires Oct. 23, 192 — .. 

1 If the affiant is the sole owner of the claim, leave space blank; if not the sole owner, fill 
out as the facts may be, as “a member of the firm of A. B. & Co., consisting of” (give the full 

name of each member of the firm), or “Treasurer of The .... .. Company, a 

corporation under the laws of. ......-........ .... • • ” . „ . . 

2 Fill out, as the facts may be, as goods and merchandise sold and delivered, labor done 
and performed,” "professional services rendered as physician,” etc. 

* If there are, fill out “except as set forth in the attached claim.” 


Form 15, Affidavit in Proof of Claim 

The sole reason for this variation in procedure is one of con¬ 
venience, inasmuch as blank proofs of claim, a supply of which 
is usually to be found in every credit department, may be ob- 
























276 


RIGHTS AND REMEDIES OF CREDITORS 


tained from any law stationer, and forwarded to the attorney 
at the creditor’s convenience. 

The distinction is to be noted between such an affidavit 
in proof of claim and the prescribed bankruptcy affidavit in 
proof of debt, because whereas the former may be executed 
by any officer of the corporation, the latter must be executed 
by the treasurer, or the officer whose duties most closely cor¬ 
respond with the usual and customary duties of a treasurer. 

Thus, is an action at law instituted by the creditor, or 
plaintiff, in the proper court for the collection of a debt, a 
formal complaint or declaration of his cause of action is made. 
A summons to appear and make answer to this complaint is 
then served on the debtor, or defendant. (See Form 16.) 

If the defendant cannot be found within the jurisdiction 
of the court, methods are provided whereby any property of 
his located within the state may be attached and subjected to 
the payment of his debts. (See “Attachment,” Chapter 
XXV.) 


SUMMONS 


Municipal Court—City of Cincinnati, County of Hamilton, 
State of Ohio 


_ <y 

The Crocker & Bramble Distributing Co. 

Plaintiff , 


against 

Mary Volmer, 

doing business as “Volmer’s Home Bakery” 

Defendant. 


> Summons. 


To the above named Defendant: 

You are hereby summoned to answer the complaint in this action, and 
to serve a copy of your answer on the Plaintiff’s Attorney within twenty 
days after the service of this summons, exclusive of the day of service, and 
in case of your failure to appear, or answer, Judgment will be taken against 
you by default for the relief demanded in the complaint. 

S. Farrar Long, 

Dated, Cincinnati, February 18, 192— Plaintiff's Attorney . 

Post-Office Address and Office, Gwynn Building, Cincinnati, O. 


Form 16. Summons Served on Debtor 




LEGAL PROCESS 


2/7 


Framing an Issue 

Then follow the various pleadings which may be interposed 
by the parties until a definite issue of fact is arrived at. The 
pleadings are: 

1. Declaration, or complaint by the plaintiff. 

2. Plea, or answer by the defendant. 

3. Replication, or reply by the plaintiff. 

4. Rejoinder by the defendant. 

Beyond these the pleadings seldom extend further. Upon 
these documents, or others which may be allowed, the issue is 
framed, that is, the question in dispute is made clear. 

Issue having been joined, the case is then listed for trial, 
or docketed, on the trial calendar. 

Trial 

When the time set for the trial arrives, unless there is some 
special defense for non-payment to be interposed in the nature 
of a “set-off,” or “counterclaim,” the debtor generally permits 
judgment to be taken against him by default, for failure to 
answer, meaning that he simply does not put in an appearance 
in court, either personally or represented by an attorney to 
contest the claim. This judgment is simply the decision of 
the court upon the issue raised by the pleadings. 

If, however, the case is to be contested by the debtor, what¬ 
ever questions of law arise during the course of the trial are 
decided by the court. Questions of fact arising, however, are 
decided by the jury. The right to a jury trial may, however, 
be waived by the parties, and the costs of the action thereby 
curtailed. In most jurisdictions if the amount involved is 
less than $20, a party is not entitled to demand a jury trial. 

Both parties are then afforded an opportunity to submit 
whatever evidence they wish to offer in support of their side 
of the controversy, and the burden of proof rests upon the 
plaintiff to prove his case by a preponderance of the evidence 
submitted. 


278 RIGHTS AND REMEDIES OF CREDITORS 

If the jury or court, as the case may be, finds for the plain¬ 
tiff, judgment is entered accordingly. 

The Judgment 

Such a judgment is theoretically the end of the action. 
But it recognizes no liens, and awards no execution against 
specific property. It contains simply the conclusion of the law 
upon the facts as set forth in the complaint, and leaves the 
judgment creditor to his legal and appropriate writ to enforce 
it. In other words, such a judgment is not of the self- 
executory kind. 

Upon being docketed, however, the judgment becomes a 
lien upon whatever real estate the debtor may own within the 
county in which it was rendered. If the real estate is located 
in a different county within the state, a copy of the judgment 
must also be docketed in that county to create a lien on the 
realty. 

Appeal 

The defeated party may, however, appeal from the judg¬ 
ment. If he decides to do so, his attorney prepares a trans¬ 
cript of the evidence, and with this, after giving notice to his 
adversary, goes before an appellate court of judges and asks 
to have the judgment reversed. Argument on both sides is 
heard by the appellate court, and if the court finds a substan¬ 
tial error, or that the judgment is unsupported by the evidence, 
it may reverse the judgment and order a new trial. Other¬ 
wise it affirms the judgment. 

The phrase “judgment is reversed” is misleading in that it 
does not really constitute a reversal of the judgment. For 
example, A sues B and obtains a judgment. The case is ap¬ 
pealed by B, and the judgment is reversed. This does not 
mean that the court is thereby deciding that B does not owe 
A, but rather that some prejudicial error was committed in 
the proceedings in the lower court, which entitles B to a new 


LEGAL PROCESS 


279 


trial, wherein such error will not be repeated. In other words, 
instead of actually reversing the judgment, it merely serves to 
set it aside and thus render it unenforcible. 

Execution 

After the judgment is obtained, the law in most jurisdic¬ 
tions allows the defendant a certain length of time in which to 
settle in court the claim or judgment, including the court costs, 
and when this time has expired it is the privilege of the at¬ 
torney for the plaintiff to request the issuance of a writ of 
fieri facias, commonly referred to commercially as a “writ of 
execution,” which is a warrant directing some subordinate 
officer of the court, usually the sheriff, “to cause to be made” 
the amount of the judgment out of the personal property, 
goods, and chattels of the debtor by seizing all or sufficient 
property of the debtor over and above that which the law 
allows him as exempt from execution (the amount of which 
varies in the different states), to satisfy the claim and cover 
the court costs. Such seized property is then advertised for 
sale in accordance with the prescribed legal requirements and 
later disposed of at a public sale. 

Where the realty is situated in a different county within 
the state than that in which the judgment was obtained, it is 
necessary to docket a copy of the judgment in the county in 
which the realty is situated before execution may be levied 
upon it. 

Rights of Purchaser Arising Out of Sales on Execution 

Property conveyed in fraud of creditors may be seized in 
the hands of the fraudulent grantee as though no conveyance 
had been made, and sold on execution as the property of the 
grantor. It therefore follows that the execution purchaser 
obtains a perfect legal title, subject to the burden of proving 
the conveyance fraudulent in event the grantee asserts its 
validity. 


28 o 


RIGHTS AND REMEDIES OF CREDITORS 


Rights of Execution Creditor Purchasing at His Own Sale 

It is well-settled law that a third person purchasing prop¬ 
erty at a sheriff’s sale, innocently and without knowledge of 
any defects in the title of the property, takes free of all equities. 
Does the same rule apply to a judgment creditor? 

It has been held that a judgment creditor buying without 
notice at his own sale is not a purchaser for value. But this 
position seems questionable. The creditor may, it is true, pass 
over no money on his bid, but as a consequence of the trans¬ 
action he does release his judgment claim. The result is in 
no way different from that which would have been reached 
had he paid cash to the sheriff and received it back in satisfac¬ 
tion of the judgment. Following this reasoning, some courts 
have held that the judgment creditor purchasing in good faith 
at the execution sale acquires a clear title. 

This principle was also upheld in a case in which the de¬ 
fendant attached certain land, and at the execution sale bought 
the land himself. Prior to the attachment the land had been 
conveyed to the plaintiff by an unrecorded deed. The court 
held that the defendant under such circumstances takes clear 
of the plaintiff’s equity. 

The Return 

In event the sheriff is unable to locate any assets on which 
to levy, he makes his return as having found the debtor execu¬ 
tion-proof, and there remains but one course to pursue— 
arrange to investigate the debtor’s affairs every 6 months in 
the hope that he has prospered sufficiently in the meantime 
to justify serving another writ of execution. 

Loss Accounts 

It is a great mistake to destroy a claim as worthless be¬ 
cause the debtor has been found execution-proof. The author 
has collected many such claims in full with interest (the law 
allows interest on judgments until paid), or has succeeded in 


LEGAL PROCESS 


281 

effecting a partial settlement four or five years after the claim 
had first been returned as worthless. To follow them up until 
outlawed by the Statute of Limitations on Judgments is not 
only a profitable policy to pursue, but the moral effect in hold¬ 
ing such debtors to their obligations, if practiced extensively, 
would undoubtedly be very effective and beneficial from a busi¬ 
ness standpoint. Accurate, complete, and carefully kept loss 
records in ledger or account form should constitute a part of 
the records of every up-to-date credit department. 

Statute of Limitations 

The common law sets no limit to a plaintiff’s right to bring 
suit upon a claim or for a breach of contract, but every state 
in the union has enacted a statute limiting the period within 
which such action may be begun. This law is called the 
“Statute of Limitations.’’ However, such statutes affect only 
the plaintiff’s, or creditor’s, remedy and not his right of action. 
The debt, in so far as the moral obligation is concerned, per¬ 
sists and continues even after the statute has run, but the pay¬ 
ment of it has been rendered unenforcible at law. In other 
words the statute does not operate to cancel the debt, but merely 
to withdraw the remedy. 

In the case of simple contracts the time limit fixed by the 
statutes is usually from three to eight years. For notes and 
judgments the period is usually longer. It varies somewhat in 
the various states, so that the state statutes must always be 
consulted to determine whether or not one’s rights under a con¬ 
tract are barred by statute. As a rule, the statute runs from 
the date of the last payment, if the full amount of the claim 
is due at that time. 

When the prescribed period within which such actions must 
be brought has elapsed, the contract, or right of action upon it, 
is said to be “outlawed,” meaning that as a result of his delay 
in prosecuting his legal rights within the specified time the 
plaintiff has lost whatever right to prosecute he may have had. 


282 


RIGHTS AND REMEDIES OF CREDITORS 


There are four special circumstances, however, which may 
be said to “take the case out of the statute,” meaning that they 
constitute exceptions to which the statute does not apply. 
They are: 

1. The payment of interest. 

2. Part payment of the principal. 

3. A new promise to pay in writing. 

4. A written acknowledgment of the indebtedness. 

Part Payment and the Statute of Limitations 

There is a distinct advantage in accepting or effecting part 
payment from time to time, to apply on past-due accounts, be¬ 
cause such payments constitute an acknowledgment that the 
debt is due and strengthens a creditor’s position legally, as the 
Statute of Limitations on open accounts begins to run from 
the date of the last payment on account, instead of from the 
date on which the indebtedness was originally incurred. This 
means that by accepting part payments from time to time the 
creditor extends the time within which he may enforce pay¬ 
ment of the account before it becomes outlawed by the statute. 

For clearness, let us suppose an imaginary case. Suppose 
on October 1, 1915, A’s account with you showed a matured in¬ 
debtedness of $500, and you withdrew his line of credit. In¬ 
vestigation proved his affairs to be in such bad shape that suit 
on the claim was inadvisable. Then let us further assume 
that he continued in business for 7 years in approximately the 
same condition, never seeming sufficiently prosperous to justify 
suit being brought, and that you made no effort to effect a 
part payment on the account. On October 1, 1921, the claim 
is outlawed (assuming statute to be 6 years). Your loss was 
$500 plus interest at 6 per cent, or a total of $680. 

Next, let us suppose that on December 1, 1918, when the 
prospects seemed favorable for A to get back on his feet, you 
succeeded by threats of suit, bankruptcy, etc., in wheedling a 
payment on account of $50 out of him, and by 1923 he was 


LEGAL PROCESS 


283 


again on his feet. The statute, dating from the time of his 
part payment in December, 1918, had a year to run, so that 
you were in a position to force payment of the remaining $450, 
with the legal rate of interest which the law allows on past-due 
accounts. This payment would be figured as follows : 


October 1, 1915—Matured indebtedness. $500 

December 1, 1918—Part payment. 50 


(Statute thereby extended from October, 1921, to De¬ 
cember, 1924.) 

December 1, 1923, balance of $450 plus interest at 6 per cent. 660 

Loss. $716 

If it had not been for the part payment of $50 in 1918 
your claim would have become outlawed in 1921, with an inci¬ 
dental loss of $500 plus interest, or $680. 

Instances of this nature are not so rare as may be supposed, 
and it simply illustrates the importance of a credit man being 
familiar with the little ins and outs of the game, which make 
for efficiency in his work. 

A debt may also be revived by a new promise to pay it 
after it is barred by the Statute of Limitations. Almost all the 
states require such a promise to be in writing. 

Supplementary Proceedings 

The situation with which supplementary proceedings has to 
deal is of somewhat this nature. Suppose you have a claim 
against a debtor, and at the time suit is brought he apparently 
has ample assets out of which to satisfy your judgment. But 
after having reduced your claim to judgment, he is found to 
have dispossessed himself of all such available assets and 
rendered himself execution-proof. Under such circumstances 
suspicion would naturally attach to the manner in which the 
assets were transferred to some third party; or if sold, as to 
the disposition of the proceeds from the sale. 

Of course, the debtor is not going to disclose voluntarily 
to you or your attorney anything he does not want you to 






284 RIGHTS AND REMEDIES OF CREDITORS 

know. And yet, under the circumstances you have as a matter 
of justice a right to know something about the transfer of his 
property in order to satisfy yourself that there was nothing 
fraudulent connected with it, particulary in view of the fact 
that the primary object of the law is to promote justice by 
compelling men to perform and carry out their just and honest 
obligations to one another. The law gives a judgment creditor 
such a right by providing an opportunity for him to examine 
the debtor under oath in what are known as “supplementary 
proceedings,” meaning, of course, proceedings supplementary 
to the judgment obtained. 

Purpose of Supplementary Proceedings 

The purpose, then, of supplementary proceedings is to 
afford a judgment creditor the right and opportunity to ex¬ 
amine the judgment debtor, or any person indebted to the 
judgment debtor, for any property belonging to him, and also 
to provide for the application of such discovered property or 
debt to the payment or satisfaction of the judgment. 

This two-fold purpose can be accomplished in either of 
two ways: 

1. By the appointment of a receive. 

2. By an order of the court directing the surrender or 

delivery of the property to the sheriff. 

In other words, the purpose of the proceeding is similar 
in nature to the examination of a bankrupt in bankruptcy pro¬ 
ceedings. However, in order to be entitled to such an order 
for the examination of the judgment debtor, or person indebted 
to him, an execution must have first been issued and returned 
unsatisfied. Thereafter, the right may be exercised at any 
time within the statutory period—usually 10 years. 

Creditor Entitled to One Examination Only 

The creditor has a right to only one examination of the 
judgment debtor or third person indebted to the judgment 


LEGAL PROCESS 


285 

debtor, in supplementary proceedings. But he may later ap¬ 
ply to the court for a subsequent order or orders, which will 
be granted whenever he can show facts that have developed 
subsequent to the first examination, which in the opinion of 
the court warrant a second or further examination. 

In event the judgment debtor, or third person, fails to 
appear in response to such a court order, he may be declared 
in contempt of court and punished accordingly. 

Life Insurance Policies 

As a rule, one of the first inquiries made of the judgment 
debtor in supplementary proceedings is whether or not he 
carries any life insurance. The reason for this is that while 
ordinarily the right of a beneficiary of an insurance policy 
is a vested right, if there is a reservation in the policy giving 
the insured the right to change the beneficiary, a judgment 
creditor of the insured may recover the surrender value of the 
policy. 

An exception to this general rule is where the beneficiary 
is the wife of the insured, in which case she is generally en¬ 
titled to an amount equal to the amount of insurance that could 
have been carried by the insured for a premium not exceeding 
a certain fixed sum ($500 in New York). In other words, 
you can have an execution running against a debtor’s life 
insurance. 

Circumstances under Which the Right May be Exercised 

The right to examine a debtor in supplementary proceed¬ 
ings for the purpose of having his property applied in satis¬ 
faction of a judgment may be exercised at law to enforce the 
collection of any money judgment except in the following: 

1. To apply property exempt by law from levy and sale 

under execution. 

2. To apply trust property held for the benefit of the 

judgment debtor, but proceeding from another person. 


286 


RIGHTS AND REMEDIES OF CREDITORS 


3. Ordinarily, 60 days’ earnings, when such earnings are 
necessary for the support of his family. 

In all other cases, the judgment debtor, or third person 
charged with being his debtor or bailee, is directed by the order 
to appear before the court or referee at the time and place 
specified, and to submit to an examination concerning the prop¬ 
erty of the judgment debtor, who thereupon may be enjoined 
from transferring or otherwise disposing of it until authorized 
by the court. 

Upon the return day of the order, the judgment debtor or 
third party so summoned is sworn by the judge or referee and 
questioned by the judgment creditor’s attorney. The testi¬ 
mony is taken down, and when completed must be signed by 
the witness and sworn to before the judge or referee. 

Remedy Is Statutory 

Here again the remedy is one which is entirely statutory, 
and such remedy exists only where the state statutes so pro¬ 
vide for it; but it is a remedy which has been provided for in 
most states, although the precise nature of the proceeding is 
not always uniform. 

Exemptions 

In every state a law has been enacted exempting a certain 
amount of a debtor’s property from all liability for his debts, 
which shall not be taken on attachment or execution. The pur¬ 
pose of the law is to prevent people from being deprived of 
their means of earning a livelihood, and reduced to poverty, 
thus becoming a charge on the community. Some of the 
statutes enumerate the articles exempted quite minutely, such 
as the necessary furniture, needful clothing, schoolbooks, a 
certain amount of food and fuel, the tools of a trade, etc., and 
then add that other necessary articles not exceeding a certain 
amount in value are also exempted. 

In most of the states a small homestead is protected from 


LEGAL PROCESS 


287 


creditors and exempted from attachment or execution. Vari¬ 
ous provisions are made in the different states to combine a 
due protection of the creditor with proper prevention of fraud. 
The most common means adopted is that of requiring that the 
homestead should be distinctly defined and set apart, and in 
many cases by the additional requirement that the description 
and location of it should be put on public record. 

The significance of the exemption laws to a credit man is 
that it is necessary for a creditor to know what legal exemp¬ 
tions the debtor is entitled to, for the true net worth of the 
debtor’s estate is correspondingly reduced to the extent of the 
exemption. In considering financial statements of merchants 
of limited financial responsibility it is especially important to 
know just what part of the assets may be exempted from 
creditors’’ claims by the state law. The following summary of 
the main items of exemption which prevail in the different 
states is given: 

Alabama 

Homestead: 160 acres, value $2,000. 

Personal Property: $1,000. 

Wages up to $25 a month. 

Arizona 

Homestead: $4,000. 

Stock in Trade: $400. 

Life Insurance: $10,000. 

One-half man’s salary for 30 days. 

Arkansas 

Realty: 60 acres in country, value $2,500; 1 acre in city, value $2,500. 
Household Belongings: $200. 

Other Personalty: $500. 

California 

Homestead: $5,000, if head of family; $1,000, if any other person. 
Household Belongings: $200. 

Personal Property or Stock in Trade: $1,000. 

Wages for 30 days preceding levy. 

Life insurance on which premium does not exceed $500. 


288 


RIGHTS AND REMEDIES OF CREDITORS 


Colorado 

Homestead: $2,000. 

Household Furniture: $100. 

Tools, Implements, or Stock in Trade: $200. 

Wages: 60 per cent over and above $5 a week. 

Connecticut 

Homestead: $1,000. 

Household Furniture: $150. 

Business Equipment: $250. 

Wages to amount of $25. 

Delaware 
No real estate. 

Tools, Fixtures, or Stock in Trade: $75. 

Head of Family: $200 additional. 

(Exemptions vary in different counties.) 

District of Columbia 
No real estate. 

Household belongings: $300. 

Tools, Implements, or Stock in Trade: $200. 

Pictures, Books, and other Personal Property: $400. 

Wages of head of family, not to exceed $100 a month for previous 60 
days. 

Florida 

Realty: 160 acres and improvements in country, Y2 acre in city with 
improvements. 

Personal Property: $1,000 (only to head of family). 

All wages due. 

Georgia 

Aggregate real and personal property: $1,600. 

Wages up to $1.25 a day, and 50 per cent thereover. 

Idaho 

Homestead: $1,000 for single man, and $5,000 for family. 

Household Belongings: $300. 

Tools, Implements or Stock in Trade: $500. 

75 per cent of earnings for preceding 30 days, not to exceed $100. 

Illinois 

Homestead: $1,000. 

Personal Property: $100. 

Head of family: An additional $300 if selected property. 

Wages not exceeding $15 a week. 


LEGAL PROCESS 


289 


Indiana 

Real and Personal Property: $600. 

Wages up to $25. 

Iowa 

Real Estate: 46 acres in country, and Y2 acre in city. 

Household Belongings: $200. 

Earnings for 90 days preceding levy. 

Kansas 

Real Estate: 160 acres in country, with improvements, and 1 acre in 
city, with improvements. 

Household Furniture: $500. 

Tools, Implements, Stock in Trade: $400. 

Wages: All but 10 per cent for preceding 3 months if necessary for 
support of family. 

Kentucky 
Real Estate: $1,000. 

Tools, Equipment, etc.: $100. 

Furniture, etc.: Sufficient for family use. 

90 per cent of salary or wages not to exceed $75, otherwise $67.50. 
Louisiana 

Real Estate: 160 acres, whether rural or urban, and improvements. 
Implements, Tools, or Stock in Trade: $2,000. 

All wages. 

Maine 
Realty: $500. 

Furniture: $100. 

Tools, Implements: $50. 

Library: $150. 

Life Insurance: Premium not to exceed $150. 

Wages for 30 days preceding levy not to exceed $20. 

Maryland 

Property: $100. 

In addition thereto, all wearing apparel, books, and tools. 

Wages not to exceed $100. 

Massachusetts 
Homestead: $800. 

Household Belongings: $300. 

Tools, Implements, or Stock in Trade: $100. 

Wages not to exceed $20. 


290 


RIGHTS AND REMEDIES OF CREDITORS 


Michigan 

Realty: 40 acres in country and not to exceed $1,500 in city. 
Household Furniture: $250. 

Stock in Trade, etc.: $250. 

Wages up to $25. 

Minnesota 

Realty: 80 acres in country, and acre in city. 

Household Furniture: $500. 

Tools, Implements, Stock in Trade: $400. 

Wages not to exceed $35, if earned within 30 days preceding. 

Mississippi 

Homestead: $2,000 ($3,000 if by formal declaration). 

Tools, Implements, etc.: $500. 

Household Furniture: $250. 

Wages: $50 a month. 

Life Insurance: $10,000. 

Missouri 

Realty: $1,500 in country land, $3,000 in city property (population 
over 40,000), and $1,500 in city property (population less 40,000). 
Personal Property, or Additional Realty: $300. 

Wages: 90 per cent to heads of families. 

Montana 

Unmarried Person: Wearing apparel only. 

Realty: $2,500. 

Personal Property: $200. 

Wages for 40 days. 

Nebraska 

Homestead $2,000 or Personal Property: $500. 

Wages: 90 per cent to heads of families. 

Nevada 

Homestead: $5,000. 

Necessary household furniture. 

Wages: Not to exceed $50. 

New Hampshire 
Homestead: $500. 

Furniture: $100. 

Tools, Implements, etc.: $100. 

Wages: $20 (except for necessities). 


LEGAL PROCESS 


291 


New Jersey 

Homestead: $1,000. 

Personal Property: $200. 

Wages: Over $18 per week subject to garnishment of 10 per cent. 

New Mexico 

Homestead: $1,000. 

Household Furniture. 

Tools, Implements, etc.: $150. 

Wages: No more than 20 per cent for last 30 days may be garnished 
unless in excess of $75. 

New York 

Homestead: $1,000. 

Household Goods: $250. 

Wages: 60 days. 

North Carolina 

Homestead: $1,000. 

Personal Property: $500. 

Wages for 60 days. 

North Dakota 

Homestead: $5,000. 

Personal Property: $500. 

Ohio 

Homestead: $ 1,000; or, 

Personal or Real Property: Not to exceed $500. 

Household Furniture: $35. 

3 months’ earnings (if head of family). 

Oklahoma 

Homestead: $5,000. 

Household Furniture. 

Tools and Implements. 

Wages for 90 days. 

Oregon 

Homestead: Owned and occupied by family not to exceed $3,000. 
Household Goods: $300. 

Wearing Apparel: $100. 

Tools, Implements, etc.: $400. 

Wages for preceding month, not to exceed $75. 


2<)2 


RIGHTS AND REMEDIES OF CREDITORS 


Pennsylvania 
No Homestead. 

Real or Personal Property: $300. 

All wages. 

Rhode Island 

• 

No Homestead. 

Tools, Implements, etc.: $200. 

Household Furniture: $300. 

Salary or wages to amount of $10. 

South Carolina 

Homestead: $1,000. 

Personal Property: $500. 

Wages for 60 days. 

South Dakota 
Homestead: $5,000. 

Personal Property: $750 for married men and $350 for single men. 
Wages for 60 days. 

Tennessee 

Homestead: $1,000. 

90 per cent of income already earned by one earning $40 a month 
less; and $36 when the amount exceeds $40. 

Texas 

Homestead: $5,000. 

Household Furniture: 

Implements and Tools: 

Current wages. 

Utah 

Homestead: $1,500. 

Household Furniture: $300. 

Implements, Tools, etc.: $300. 

Wages: x /i earnings for 30 days. 

Life Insurance: Premium not to exceed $500. 

$500 for wife; $250 for each other member of family. 

Vermont 

* 

Homestead: $1,000. 

Personal Property: $200. 

Tools, Implements. 

Wages for 2 months not to exceed $50 a month. 


LEGAL PROCESS 


293 


Virginia 

Homestead: $2,000 (must be recorded). 

Household Belongings. 

Tools, Implements, or Stock in Trade. 

Wages not to exceed $50 a month. 

Washington 

Homestead: Consisting of dwelling house in which claimant resides. 
Furniture: $500. 

Tools, Implements, or Stock in Trade: 

Current Wages: $100 (not to exceed 4 weeks’ pay). 

West Virginia 

Homestead: $1,000 (must be recorded). 

Personal Property: $200 (if married). 

Tools and Implements: $50. 

Current Wages. 

Wisconsin 

Homestead: $5,000. 

Household Furniture: $200. 

Wages: Married man, 3 months (not to exceed $180). 

Wyoming 

Homestead: $2,500. 

Household Belongings: $500. 

Tools, Implements, etc.: $300. 

Wages: Yi of wages for service rendered within 60 days of executions, 
not to exceed $100. 

For ready reference purposes, complete digests of the 
state exemption laws are contained in the quarterly rating 
books of both Bradstreet and Dun. 

Meaning of “Due Process of Law” 

By “due process of law,” in this connection, is meant that 
in order to obtain a valid personal judgment against a debtor 
he must be personally served with notice of the suit within the 
state. Or, to put it in another way, it means that you cannot 
obtain a valid personal judgment (directing a person to do 
something) which will be recognized by and enforced in other 
states, where notice of the suit is given to the debtor, outside 


294 


RIGHTS AND REMEDIES OF CREDITORS 


the state, by publication. A state statute may authorize the 
rendering of personal judgments where the debtor has been 
served with notice by publication, but other states are not 
compelled to recognize and enforce them, because such judg¬ 
ments are not deemed to have been obtained by due process of 
law. 

The importance of this fact is brought out in a situation 
where a judgment has been obtained, say in the New York 
courts, against a non-resident debtor, who has been served 
with notice of the suit by publication; and you then wish to 
execute the judgment against property of the debtor within 
the state of New York. It cannot be done, because your judg¬ 
ment is invalid—there having been no personal service within 
the state—and you therefore cannot seize property of the 
debtor within the state to satisfy it . 1 Does this mean that a 
creditor is powerless to subject the property of a non-resident 
debtor to the satisfaction of his claim or account? No, it 
simply means that it must be accomplished in a different way. 

Proper Way to Subject Property of a Non-Resident to a 

Creditor’s Claim 

The proper procedure to be followed when you are deal¬ 
ing with such a situation is: 

1. Attach the property on the ground that the debtor is a 

non-resident of the state (always a good ground for 
attachment). 

2. Get a judgment against the property thus attached. 

Such a judgment is not a personal judgment against a per¬ 
son outside the state, and therefore outside the jurisdiction 
of the state courts, but a judgment against property within the 
state and therefore within the jurisdiction of the state courts. 

In other words, if you have a claim against a non-resident 
who has property within the state which can be levied on and 


1 Pennoyer v. Nehf, 59 U. S., 714. 



LEGAL PROCESS 


295 

subjected to execution: (1) attach the property, (2) get a 
judgment against that particular property. 

Enforcement in One State of Judgment Obtained in Another 

It is not an uncommon view in the commercial world that 
once a legal judgment is obtained against a debtor in one 
state, it is enforcible against the person or property of the 
debtor in any and every other state, on somewhat the same 
theory or principle that a marriage valid in the state in which 
it is performed is recognized as valid in every other state. 
While the latter statement, from a strictly legal viewpoint is 
true, the former is not. By this is meant that it is entirely 
possible for a creditor to obtain a judgment against a debtor 
which is enforcible only within the state in which it was ob¬ 
tained, that is, a judgment which will be given no ex-terri¬ 
torial effect. Hence the importance to a credit man of know¬ 
ing just when and under what circumstances and conditions a 
judgment can be obtained against a debtor which may be en¬ 
forced against property of the debtor located in another state; 
and of knowing the manner in which and procedure whereby 
such judgments are executed and enforced in foreign states. 

State Jurisdiction Confined to State 

In the first place, the fact must be recognized that each state 
is a sovereign unto itself and has a sovereign’s right to exer¬ 
cise control over all property and persons within the state. 
Therefore, after you have obtained a judgment in one state 
and attempt to enforce it against the person or property of the 
debtor in another state, you are immediately confronted with 
this question: “By what right are you attempting to seize 
or attach property in this state,” say New Jersey? 

You then state your position to be that of a holder of a 
judgment obtained in New York, we will assume. But the 
New York courts have nothing to do with and exercise no 
jurisdiction or control over persons or property located within 


296 RIGHTS AND REMEDIES OF CREDITORS 

the state of New Jersey. The exercise of their sovereign 
rights and powers is limited and confined to the state of New 
York. In other words, strictly speaking, the judgments of 
state courts are effective and binding only within the jurisdic¬ 
tion of the state in which they are obtained. 

Effect of Constitutional “Full Faith and Credit Clause” 

We turn now to article 4, section 1, of the United States 
Constitution, which is known as the “full faith and credit 
clause” of the Constitution, and which provides that: 

Full faith and credit shall be given in each of these states 
to the records, acts, and judicial proceedings in every other 
state. 

By that is meant that once you have obtained a valid judg¬ 
ment in one state by due process of law, the courts of other 
states are compelled to take judicial notice of that fact in this 
way: 

In order to enforce a judgment in one state, say New Jer¬ 
sey, it must be a New Jersey judgment. But once you have 
obtained a valid judgment in another state, all you have to do 
in order to obtain a judgment to the same effect in New Jersey 
is to prove to the satisfaction of the New Jersey court that 
your judgment in the other state was obtained by due process 
of law, and on the strength of that fact they will grant you a 
New Jersey judgment, thereby enabling you to enforce the 
judgment obtained in the other state, within the state of New 
Jersey. This is what is meant by the “transfer of a judg¬ 
ment from one state to another,” discussed below. 

The principal difference between the two judgments thus 
obtained lies in the manner in which they are obtained. To 
get your first judgment you have to prove your original cause 
of action, whereas to obtain your second, all you have to do is 
to prove that your first judgment was obtained by due process 
of law. 


LEGAL PROCESS 


297 

Procedure Incidental to the Transfer and Enforcement of 

Judgments from One State to Another 

The procedure incidental to the transfer and enforcement 
of judgments can perhaps best be explained by means of a 
concrete illustration. Let us take the case of X suing Y for 
goods sold and delivered, in the Supreme Court of New York 
County, for the sum of $3,500, and let us assume that X 
recovers a judgment against Y for that amount by default, 
owing to Y’s failure to defend the suit. Let us also assume 
that an execution has been levied against the property of Y 
in New York, but the sheriff finds that Y has moved to New¬ 
ark, New Jersey, and returns the writ of X unsatisfied. What 
remedy has X now against Y? 

X can go to the Supreme Court of New York County and 
get an exemplified copy of the New York judgment roll, which 
consists of a copy of the judgment roll signed by the judge of 
the court and two clerks of the court, and contains a copy of 
the summons, the pleadings, admissions, the final judgment, 
any interlocutory judgment or decrees, and a copy of any 
paper or order on file which in any way involves the merits or 
necessarily affects the judgment. If judgment is entered by 
default, the written proof required to be filed by the plaintiff 
and the result must be contained in the judgment roll, together 
with the damages assessed. The judgment roll does not, and 
should not, contain any evidence of the case. 

X then brings his action against Y in the Supreme Court 
of New Jersey, in the city of Newark, and Y is accordingly 
served with a summons to appear in this action. X presents 
his exemplified copy of the New York Supreme Court judg¬ 
ment roll, and alleges that the Supreme Court of New York 
had jurisdiction over the subject matter of the action and like¬ 
wise the amount involved. He further alleges that no part of 
the sum has been paid, that the execution levied under the 
judgment was returned unsatisfied, and then rests his case. 

On the strength of these allegations the New Jersey 


298 rights and remedies of creditors 

Supreme Court will give X a judgment for $3,500 plus costs 
against Y. The sheriff of Newark will then levy on Y’s 
property and collect the $3,500 judgment plus the costs of the 
New York judgment. In other words, X gets double costs 
against Y, as the New York costs are added to, and included 
in, the judgment roll when X presents it to the New Jersey 
court. 


CHAPTER XXV 

GENERAL RIGHTS AND REMEDIES 

i. Legal Rights and Remedies of the Seller 

Unpaid Seller’s Lien 

An unpaid seller of merchandise is protected by law to 
the extent that under certain circumstances and conditions he 
may exercise special rights against the goods sold notwith¬ 
standing the fact that title to the goods has passed to the buyer. 
A seller is still unpaid if he has been given a bad check or note 
in return for the goods. The first of these rights that we will 
consider is the unpaid seller’s lien. 

A lien is the right of one party to retain in his possession 
goods, the title to which is in another party, until the demands 
of the party in possession have been satisfied. In other words, 
in the case of the unpaid seller’s lien, the term implies that 
the purchaser continues to be the owner of the goods, but that 
the seller, who is described as the “holder” of the lien, has 
acquired a claim upon the goods—not a claim of ownership, 
but a claim of right to hold the goods as security for the per¬ 
formance of the obligation of the purchaser to pay for them 
in accordance with his promise. 

As for the circumstances under which this right or remedy 
may be exercised, there are two possibilities to be considered: 

i. When No Credit Is Extended. Where merchandise 
is sold without any agreement as to the extension of credit to 
the buyer, title may pass, but the seller may retain possession 
of the goods, or exercise a seller’s lien, until paid for. In 
other words, where you have a bargain and sale at an agreed 
price, the modern presumption is that title to the goods passes 


299 


300 


RIGHTS AND REMEDIES OF CREDITORS 


immediately, but the seller retains a lien on the goods until 
paid for. 

2. When Credit Is Extended. Even where the goods 
are sold on credit, if the buyer becomes insolvent before de¬ 
livery the seller thereupon becomes vested with the right to 
exercise an unpaid seller’s lien and to refuse to deliver the 
goods until paid for. 

The theory or principle upon which this right is based is 
that, while the seller, in extending credit to the buyer, waived 
his lien or right to hold the goods until paid for, he did so on 
the implied condition that the buyer’s credit standing and 
financial responsibility would remain unimpaired. It is the 
breach of this implied condition which gives rise to the right 
or lien. 

When the Right May be Exercised 

The lien of the unpaid seller for the purchase price of the 
merchandise exists only: (i) when the seller has sold for 

cash; (2) when, having sold on credit, the time for the credit 
has expired before delivery of the goods has been made; or 
(3) when, having been sold on credit, the buyer becomes 
insolvent before delivery. 

The Uniform Sales Act which has been enacted in 22 
states, sets forth the principles governing the unpaid seller’s 
lien in sections 54-56 as follows: 

(1) Subject to the provisions of this act, the. unpaid seller 

of goods who is in possession of them is entitled to 
retain possession of them until payment or tender of 
the price in the following cases: 

(a) Where the goods have been sold without any 

stipulation as to credit. 

(b) Where the goods have been sold on credit, but 

the term of credit has expired. 

(c) Where the buyer becomes insolvent. 

(2) The seller may exercise his right of lien notwithstanding 

that he is in possession of the goods as agent or 
bailee for the buyer. 


GENERAL RIGHTS AND REMEDIES 


3°i 

Where the unpaid seller has made part delivery of the 
goods, he may exercise his right of lien on the remainder, un¬ 
less the part delivery has been made under such circumstances 
as to show an intent to waive the lien or right of retention. 

When Lien Is Lost 

The lien of the unpaid seller is lost as soon as he parts with 
possession of the goods, or as soon as the purchaser tenders 
the purchase price and demands delivery. The Uniform Sales 
Act provides in section 56 : 

(1) The unpaid seller of goods loses his lien thereon: 

(a) When he delivers the goods to a carrier or other 

bailee for the purpose of transmission to the 
buyer without reserving the property in the 
goods, or the right to the possession thereof. 

(b) When the buyer, or his agent, lawfully obtains 

possession of the goods. 

(c) By waiver thereof. 

(2) The unpaid seller of goods, having a lien thereon, does 

not lose his lien by reason only that he has obtained 
judgment or a decree for the price of the goods. The 
obtaining of a judgment or decree for the purchase 
price of the goods by the seller does not operate to 
extinguish the lien. In other words, the lien is not 
merged in the judgment. Otherwise, it might amount 
to compelling the seller to surrender his goods in return 
for a worthless judgment. 

When Lien Is Revived 

If the buyer for his convenience, or any other motive, has 
left the goods in the custody of the seller until the credit period 
has expired, or has become insolvent before the credit period 
has expired, the seller’s lien is revived on the ground that the 
waiver was conditional on the buyer maintaining himself in 
good credit. In other words, if goods are sold on credit and 
nothing is agreed as to the delivery of the goods, the buyer is 
immediately entitled to possession, but his right of possession 
is not absolute and is liable to be defeated if he fails to take 


302 


RIGHTS AND REMEDIES OF CREDITORS 


delivery within the credit period, or if he becomes insolvent 
before he obtains possession. 

Stoppage in Transit 

In considering the unpaid seller’s lien as one of the unpaid 
seller’s legal rights, it was pointed out that such a lien exists 
and continues in effect only so long as the seller retains posses¬ 
sion of the goods. It therefore follows that, as a general 
rule, when the seller has voluntarily parted with the actual 
possession of the merchandise he is no longer in a position 
where he can avail himself of this means of protection. An 
exception to this general rule, however, is found in the second 
of these creditor’s rights and remedies, namely, the right of 
stoppage in transit, wherein the law goes still further in pro¬ 
tecting the seller of merchandise and provides that even if the 
seller has actually despatched the goods to the buyer and in¬ 
solvency occurs, he has a right by virtue of his original owner¬ 
ship to stop the goods in transit, because, whereas title to the 
goods has passed to the buyer on delivery to the carrier so as 
to subject him to the risk of loss, he has not an indefeasible 
right to the possession, and his insolvency without payment 
of the price defeats that right. 

Extent to Which a Creditor Is Protected by the Bill of 

Lading 

This is merely a statement of the general principle of stop¬ 
page in transit, and in order to understand the limitations 
placed upon its practical application it is first necessary to 
explain the different kinds of bills of lading that may be used 
in making shipment. 

In the first place, a bill of lading is of a twofold nature in 
that it represents: (i) a receipt for the goods shipped, and 

(2) a contract to deliver as directed in the bill of lading. This 
contract to deliver may also be said to be of a twofold nature, 
in that the obligation of the carrier may be to deliver the goods 


GENERAL RIGHTS AND REMEDIES 


303 


to A, the buyer, or to A “or order.” In the former case, where 
the carrier is directed to deliver the goods to a particular con¬ 
signee and none other, the bill of lading is said to be a 
“straight” or “non-negotiable” bill of lading; in the latter 
case, where the carrier is directed to deliver the goods to a 
designated consignee “or order,” the bill of lading is said to 
be “negotiable.” 

The important points to be noted in connection with the 
distinction between the two are: 

1. The carrier does not, as a rule, demand the surrender of 

a straight or non-negotiable bill of lading before mak¬ 
ing delivery to the consignee. The consignee in such 
instances merely has to identify himself sufficiently 
as the designated party in the bill of lading. 

2. The carrier does demand the surrender of an order bill 

before he will surrender the goods. The reason for 
this is that, being negotiable, the bill of lading (repre¬ 
senting the right to receive the goods) may have been 
transferred to some third party by the original con¬ 
signee. 

The following four cases will suffice to illustrate the extent 
to which the creditor may go in the exercise of his right of 
stoppage in transit: 

Under a Straight or Non-Negotiable Bill of Lading 

1. Suppose that after the goods are shipped to the buyer 
under a straight bill of lading, you learn of the buyer’s in¬ 
solvency. Even though title to the goods has passed to the 
buyer on delivery to the carrier, the seller may stop delivery 
of the goods at any time prior to the actual delivery of them 
to the buyer, and have them returned or held subject to other 
disposition. 

2. Suppose that the goods are shipped under a straight bill 
of lading, which is sent to the buyer, who indorses and trans¬ 
fers it to a bona fide purchaser for value before insolvency or 


3°4 


RIGHTS AND REMEDIES OF CREDITORS 


after insolvency. In neither case is the seller’s right of stop¬ 
page cut off as against the transferee, because the transfer of 
a straight or non-negotiable bill of lading amounts to nothing 
more than an assignment of the buyer’s rights under the bill 
of lading. Consequently, inasmuch as the shipper could stop 
the goods from being delivered to the original consignee, he 
can also exercise the same right against the consignee’s trans¬ 
feree of the bill of lading. 

Under an Order or Negotiable Bill of Lading 

3. Suppose that after the goods are shipped under an 
order or negotiable bill of lading, you learn of the buyer’s in¬ 
solvency, and that the bill of lading still remains in the posses¬ 
sion of the consignee (has not been negotiated to a third 
party). Just as in case (1), the seller may stop delivery of 
the goods at any time prior to the actual delivery of them to 
the buyer. 

4. Again, suppose that the goods are shipped under an 
order bill which is sent to the buyer who negotiates it to a bona 
fide purchaser for value before becoming insolvent or after 
becoming insolvent. In either case the transfer operates to 
cut off the seller’s right of stoppage against the transferee, 
section 62 of the Uniform Sales Act providing: 

If, however, a negotiable document of title has been issued 
for goods, no seller’s lien or right of stoppage in transit shall 
defeat the right of any purchaser for value in good faith to whom 
such document has been negotiated, whether such negotiation 
be prior or subsequent to the notification to the carrier, or 
other bailee who issued such document, of the seller’s claim to 
a lien or right of stoppage in transitu. 

Although it seems unjust and inequitable to permit a debtor 
to transfer title to your goods after he has become unable to 
pay for them, the theory or principle upon which the ruling 
giving him such right is based is that it is considered more 
expedient from a commercial point of view to limit the right of 


GENERAL RIGHTS AND REMEDIES 


305 


stoppage in transit of a seller who has entrusted the buyer with 
an apparently good title to the goods, than to deprive the inno¬ 
cent purchaser for value of his acquired right to the goods, 
particularly in view of the fact that the established policy of 
the courts has always been to encourage the transfer of such 
negotiable documents of title ever since they first received legal 
recognition and protection in the law courts. 

A possible fifth case might well be added, wherein the con¬ 
signee under an order bill sells the goods to a third party with¬ 
out transfer or negotiation of the bill of lading. Such a sale 
would in no way affect or cut off the seller’s right of stoppage, 
because title to the goods, as represented by the bill of lading, 
was not transferred. 

Grounds for Exercise of the Right 

The right of stoppage in transit is a legal right which rests 
solely upon the insolvency of the buyer, and is based on the 
plain reason of justice and equity that one man’s goods shall 
not be applied to the payment of another man’s debts. Actual 
or technical insolvency of the buyer is not an absolute requi¬ 
site. It will suffice if the purchaser by the manner of conduct¬ 
ing his business and meeting his obligations, manifests the 
usual evidences of insolvency. Thus, the right exists where 
the purchaser has not been able to meet his bills at maturity, or 
has permitted his notes to be protested because of his inability 
to pay them in the regular course of business. 

Consequences of Stoppage in Transit 

The effect of the exercise of this seller’s right is simply to 
restore the goods to the possession of the seller so as to enable 
him to exercise his other rights as an unpaid seller. But the 
mere fact that the seller has exercised this right does not in 
and of itself have the effect of rescinding the sale. 

The buyer whose goods have been stopped in transit, or 
those who stand in his place, may still claim and exercise the 


3°6 


RIGHTS AND REMEDIES OF CREDITORS 


right of possession if they will pay or tender the purchase 
price of the goods to the seller. 

If the seller stops the goods in transit when in fact no 
reasonable grounds for inferring the insolvency of the buyer 
exist, he may be compelled to deliver up the goods, and, in ad¬ 
dition, made to answer for any damage or loss caused the 
buyer by the delay. Furthermore, if the seller, having stopped 
the goods in transit, resells them when he ought not, the buyer 
may bring a special action against him for the damage sus¬ 
tained by such wrongful sale. 

When Does the Transit Begin and End? 

The transit of goods begins the moment the seller or his 
agent delivers the goods to the carrier. It is ended whenever 
the buyer or his agent gains possession of the goods, or when¬ 
ever the goods arrive at their destination and the carrier agrees 
to hold them as agent for the buyer. 

Section 58 of the Uniform Sales Act sets forth the circum¬ 
stances and conditions under which the goods are to be con¬ 
strued as being in transit: 

(1) Goods are in transit within the meaning of section 57, 

(a) From the time when they are delivered to a 

carrier by land or water, or other bailee for 
the purpose of transmission to the buyer, 
until the buyer, or his agent, takes delivery 
of them from such carrier or other bailee; 

(b) If the goods are rejected by the buyer, and the 

carrier or other bailee continues in possession 
of them, even if the seller has refused to 
receive them back. 

(2) Goods are no longer in transit within the meaning of 

section 57, 

(a) If the buyer, or his agent, obtains delivery of 

the goods before their arrival at the appointed 
destination. 

(b) If, after the arrival of the goods at the ap¬ 

pointed destination, the carrier or other bailee 


GENERAL RIGHTS AND REMEDIES 


3°7 


acknowledges to the buyer or his agent that 
he holds the goods on his behalf and continues 
in possession of them as bailee for the buyer 
or his agent; and it is immaterial that a 
further destination for the goods may have 
been indicated by the buyer. 

(c) If the carrier or other bailee wrongfully refuses 
to deliver the goods to the buyer, or his agent. 

(3) If goods are delivered to a ship chartered by the buyer, 

it is a question depending on the circumstances of the 
particular case, whether they are in possession of the 
master as a carrier or as agent of the buyer. 

(4) If part delivery of the goods has been made to the buyer, 

or his agent, the remainder of the goods may be 
stopped in transit, unless such part delivery has been 
made under such circumstances as to show an agree¬ 
ment with the buyer to give up possession of the whole 
of the goods. 

Manner in Which the Right Is Exercised 

No particular form or mode of stoppage has been held 
necessary in any case. When the seller wishes to exercise 
his right of stoppage in transit, he must immediately notify 
the carrier of the fact, and from the time the carrier receives 
the notice he is under obligation not to deliver the goods to 
the buyer. If he does deliver the goods to the buyer after re¬ 
ceiving such notice from the seller, he acts at his peril, section 
59 of the Uniform Sales Act providing: 

1. The unpaid seller may exercise his right of stoppage in 
transit either by obtaining actual possession of the goods, or by 
giving notice of his claim to the carrier, or other bailee in whose 
possession the goods are. Such notice may be given either to 
the person in actual possession of the goods, or to his principal. 

In the latter case, the notice, to be effectual, must be given at 
such time and under such circumstances that the principal by 
the exercise of reasonable diligence may pre\ent a delivery to 
the buyer. 

2. When notice of stoppage in transit is given by the seller 
to the carrier, or other bailee in possession of the goods, he must 


3°8 


RIGHTS AND REMEDIES OF CREDITORS 


redeliver the goods to, or according to the directions of, the 
seller. The expenses of such delivery must be borne by the 
seller. If, however, a negotiable document of title representing 
the goods has been issued by the carrier or other bailee, he shall 
not be obliged to deliver or justified in delivering the goods to 
the seller unless such document is first surrendered for cancel¬ 
lation. 

If the carrier wrongfully surrenders the goods to the buyer 
after being properly notified by the seller to stop the goods, he 
becomes liable to the seller in an action either: (i) in tort for 
conversion of the goods; or (2) for breach of contract. Reser¬ 
vation of this legal right of stoppage in transit in the seller con¬ 
stitutes an implied (when not an expressed) condition of the 
contract to deliver, and it is the breach of this implied condi¬ 
tion which gives rise to an action for breach of contract. 

When in doubt as to the proper party to whom to deliver 
the goods, the carrier as a rule returns the goods to the seller, 
who is required to execute an indemnity bond to protect the 
carrier against any claim that may be set up against him by a 
third party. 

Right of Resale 

Assuming the seller has possession of the goods as a result 
of having exercised his unpaid seller’s lien, or has recovered 
them through the exercise of his right of stoppage in transit, 
what may he do with them? Title still remains in the buyer, 
but if he does not exercise his right to tender the purchase price 
and claim the goods within a reasonable time, the seller may 
resell the goods to some third person, who in such a case would 
get a valid title thereto. In so doing he really acts as the 
agent of the buyer in whom the title rests, and makes the re¬ 
sale merely to realize upon his lien for the purchase price. 
And yet it can hardly be said that he resells the goods for the 
buyer’s account, because if that were so and the goods were 
sold at a profit the original buyer would be entitled to that 
profit. 


GENERAL RIGHTS AND REMEDIES 


309 


Time and Manner in Which Right May be Exercised 

Section 60 of the Uniform Sales Act prescribes the time 
and manner of the resale, by providing: 

1. Where the goods are of a perishable nature, or where the 
seller expressly reserves the right of resale in case the buyer 
should make default, or where the buyer has been in default 
in the payment of the price an unreasonable time, an unpaid 
seller having a right of lien, or having stopped the goods in 
transit, may resell the goods. He shall not thereafter be liable 
to the original buyer upon the contract to sell or the sale or for 
any profit made by such resale, but may recover from the 
buyer damages for any loss occasioned by the breach of the 
contract or the sale. 

2. Where a resale is made, as authorized in this section, the 
buyer acquires a good title as against the original buyer. 

3. It is not essential to the validity of a resale that notice 
of an intention to resell the goods be given by the seller to the 
original buyer. But where the right to resell is not based on 
the perishable nature of the goods or upon an express provision 
of the contract or the sale, the giving or failure to give such 
notice shall be relevant in any issue involving the question 
whether the buyer had been in default an unreasonable time 
before the resale was made. 

4. It is not essential to the validity of a resale that notice 
of the time and place of such resale should be given by the seller 
to the original buyer. 

5. The seller is bound to exercise reasonable care and judg¬ 
ment in making a resale, and subject to this requirement may 
make a resale either by public or private sale. 

Right of Rescission—When It May be Exercised 

The right of stoppage in transit, although it may seem 
equivalent in effect to a right of rescission in the limited class 
of cases where it is applicable, does no more than continue the 
seller’s lien after the property has passed from his possession. 
However, if the seller has not parted with the goods or has 
regained his lien by the exercise of his right of stoppage in 
transit, he is allowed to rescind the sale on default of the 


RIGHTS AND REMEDIES OF CREDITORS 


3 IQ 

buyer and keep the goods as his own, the rule being that a 
seller still in possession of the goods may, on default or 
repudiation of the buyer, revest himself with title when: 

1. The right to do so is reserved in the contract to the 

seller. 

2. Buyer is in default an unreasonable length of time. 

3. Buyer has repudiated the sale or is obviously unable to 

perform. 

In case of a later resale, the seller need not account to the 
buyer for any profits made by virtue of the rescission, and if 
the value of the goods at the time the sale is rescinded is less 
than the damage the seller has suffered as the result of the 
default of the buyer, he may also sue for the difference. 

As a condition precedent to the exercise of this right, 
notice of the rescission and retransfer of title should be given 
to the buyer although it has been held not to be necessary. 

Time and Manner in Which the Right May be Exercised 

Section 61 of the Uniform Sales Act also provides the time 
and manner in which the seller may rescind the original sale: 

1. An unpaid seller having a right of lien, or having stopped 
the goods in transitu, may rescind the transfer of title and resume 
the property in the goods, where he expressly reserved the right to 
do so in case the buyer should make default, or where the buyer 
has been in default in the payment of the price an unreasonable 
time. The seller shall not thereafter be liable to the buyer 
upon the contract to sell or the sale, but may recover from the 
buyer damages for any loss occasioned by the breach of the 
contract or the sale 

2. The transfer of title shall not be held to have been rescinded 
by an unpaid seller until he has manifested to the buyer by notice 
or some other overt act an intention to rescind. It is not neces¬ 
sary that such overt act should be communicated to the buyer 
but the giving or failure to give notice to the buyer of the inten¬ 
tion to rescind shall be relevant in any issue involving the 
question whether the buyer had been in default an unreasonable, 
time before the right of rescission was asserted. 


GENERAL RIGHTS AND REMEDIES 


311 

In cases where the buyer has committed a fraud in obtaining 
the goods, the seller may recover the goods, even though they 
have been delivered to the buyer, for the perpetration of fraud 
makes transfers of goods voidable. 

Action for Breach of Contract 

The seller may maintain an action against the buyer for 
the purchase price of the goods in the following situ¬ 
ations : 

1. Where title to the goods has passed and the buyer 

wrongfully refuses to pay for them according to the 
terms of the contract or sale. 

2. Where the price is payable on a specific day irrespective 

of delivery or transfer of title and the buyer wrong¬ 
fully refuses to pay. 

An action may also be brought for damages for non- 
acceptance : 

1. Where the buyer wrongfully refuses to accept and pay 

for the goods. 

2. Where the buyer repudiates the contract or sale and 

notifies the seller to proceed no further in carrying 
out the agreement. 

Measure of Damages 

In general, the rule is that where a buyer repudiates a con¬ 
tract or refuses to accept and receive the goods, the measure 
of damages is the difference between the contract price and the 
market value of the goods at the time and place of delivery. 
If the goods have no market value, the seller may recover for 
the loss shown to have resulted directly and naturally from the 
breach. If the buyer repudiates the contract or sale before it 
has been fully performed by the seller, the buyer may thus limit 
his liability to the expense incurred by the seller prior to the 
repudiation, plus the profit to be derived from the trans¬ 
action. 


3 12 


RIGHTS AND REMEDIES OF CREDITORS 


2. Legal Rights and Remedies of the Buyer 

Grounds for Right of Action 

Contracts to sell goods and sales agreements may be 
breached by the seller as well as by the buyer, and while a 
mercantile creditor is primarily interested in and concerned 
with the enforcement of his legal rights and remedies growing 
out of a breach by the buyer, nevertheless it is also well to 
know the extent to which a seller becomes legally liable for a 
breach of contract on his part. The buyer’s right of action 
may arise from either the breach of a contract to sell, or a 
contract of sale, depending upon whether title to the goods 
passes from the seller to the purchaser at the time of the agree¬ 
ment. 

Right of Action for Conversion 

1. Nature of Right. If the transaction amounted to a 
sale of the goods and title has passed, then if the seller wrong¬ 
fully refuses to deliver the goods the buyer may maintain an 
action for conversion of the goods belonging to the buyer as 
the result of the sales agreement. In such a case, however, 
the buyer does not recover the goods which constituted the 
subject matter of the transaction, but only damages. 

2. Measure of Damages. The measure of damages re¬ 
covered in such an action is the difference between the contract 
price and the market value of the goods at the time of the con¬ 


version : 

Contract price of goods. $2,500 

Value at time of conversion. 3,500 

Damages recovered. $1,000 


Right of Action for Breach of Contract 

1. Nature of Right. If, instead of a sale, the transac¬ 
tion constituted a contract to sell, and title to the goods has 
not passed, then, if the seller wrongfully refuses to deliver the 






GENERAL RIGHTS AND REMEDIES 


313 


goods, the buyer may maintain an action for damages for 
breach of contract. 

2. Measure of Damages. The measure of damages re- 

o 

covered in such an action is the loss directly resulting to the 
buyer from the breach. 


Contract price of goods... $2,500 

Potential profit from resale of goods. 3,500 

Damages recovered. $1,000 


Right of Specific Performance 

Nature of Right. In neither of the above actions has 
the buyer a right to recover the goods in specie, but damages 
only, the theory being that given sufficient damages to compen¬ 
sate him for his loss resulting from the breach, the buyer may 
go out into the open market and repurchase substantially the 
same goods for which he had previously contracted. 

In a proper case, however, the court may decree a specific 
performance of the contract by the seller. By a “proper 
case” is meant that when the nature of the goods constituting 
the subject matter of the agreement is such that they cannot 
be replaced, or if a satisfactory substitute therefor cannot 
be obtained in the open market, the buyer is. entitled to the 
benefit of his bargain which under such circumstances can be 
obtained only by receiving the goods in specie. In other 
words, while the courts will not, as a rule, decree specific per¬ 
formance of an ordinary contract for the sale of goods, be¬ 
cause the breach may be sufficiently remedied by damages, a 
sale of goods may be attended with such exceptional circum¬ 
stances as to require its specific performance to render it 
effectual. For example, in the case of the Equitable Gas Com¬ 
pany v. The Baltimore Coal Tar Company , 1 a contract was 
entered into whereby the defendant agreed to sell a certain 
quantity of coal tar to the plaintiff, and wherein it was con- 


1 63 Md. 285. 







3M 


RIGHTS AND REMEDIES OF CREDITORS 


tended that the product was not only indispensable to the busi¬ 
ness of the plaintiff, but also that a supply of it could not other¬ 
wise be obtained in the city of Baltimore. The court held that 
the contract was one of such a nature as to be specifically en¬ 
forced. 

Right of Action for Breach of Warranty 

i. Nature of the Right. When the seller commits a 
breach of warranty (express or implied), the buyer may elect 
any one of several rights of action, but if he has claimed and 
been granted a remedy in any one of these ways he cannot 
later avail himself of any of the other remedies. Under his 
rights for breach of warranty, he may: 

(a) Accept the goods and set up a counterclaim for dam¬ 

ages when sued for the purchase price. 

(b) Accept the goods, pay for them, and then maintain an 

action for damages resulting from the breach of 
warranty. 

(c) If title to the goods has not passed, he may refuse to 

accept the goods and still maintain a suit for what¬ 
ever damage he may have suffered as a result of the 
breach of warranty. This right is also permitted 
in some jurisdictions e.g., Massachusetts, when title 
has passed. 

(d) Rescind the contract to sell, or sale, and refuse to re¬ 

ceive the goods; or if the goods have already been 
received, return them, or offer to return them to the 
seller, and recover such part of the price as has been 
paid. 

The buyer, however, may not exercise his right of rescis¬ 
sion : 

(a) If he knew of the breach of warranty at the time he 

accepted the goods; 

(b) If he fails to give notice to the seller of his intention 

to rescind within a reasonable time after receiving 
the goods; or, 


GENERAL RIGHTS AND REMEDIES 


315 


(c) Unless he is in a position to return the goods in sub¬ 
stantially the same condition in which they were re¬ 
ceived. (If the deterioration or injury to the goods 
is due to the breach of warranty, such deterioration 
or injury does not prevent the buyer from rescind¬ 
ing the sale.) 

The Uniform Sales Act also provides in section 69: 

1. Where the buyer is entitled to rescind the sale and elects 
to do so, the buyer ceases to be liable for the price upon return 
ing, or offering to return, the goods; but if any part of the price 
has already been paid, the seller must repay such amount con¬ 
currently with the return of the goods or immediately after an 
offer to return the goods in exchange for the repayment of the 
price. 

2. Where the buyer is entitled to rescind and elects to do so, 
if the seller refuses to accept an offer of the buyer to return the 
goods, the buyer is thereafter deemed to hold the goods as bailee 
for the seller, but subject to a lien to secure the repayment of 
any portion of the price which has been paid, and with the 
remedies for the enforcement of such lien as are allowed to an 
unpaid seller. 

2. Measure of Damages. As a general rule or principle 
of law, the measure of damages for a breach of warranty is 
the loss directly and naturally resulting in the ordinary course 
of events from such breach. In the case of warranty as to the 
quality of the goods, such loss is measured by the difference 
between the value of the goods at the time of delivery to the 
buyer and the value they would have had if they had been as 
warranted. 


CHAPTER XXVI 

THE PROVISIONAL REMEDY OF ATTACHMENT 


Attachment Defined 

The importance of attachment as a special remedy which is 
available to creditors is perhaps most appreciated by those who 
have learned from experience that it is not only entirely pos¬ 
sible but sometimes actually develops that a debtor who ap¬ 
parently possessed ample assets at the time the suit was brought 
is found to be execution-proof, and those assets untraceable 
after a judgment has been obtained. Hence the practical value 
and advantage of a writ of attachment as a precautionary 
measure against such a contingency. 

Attachment is a legal proceeding whereby a lien on prop¬ 
erty of the debtor is secured for the benefit and protection of 
creditors. By “lien” we mean the legal right of a creditor to 
compel the property thus attached to answer for the obligation. 

Although for some purposes the issuance of the writ and 
the seizure of the property thereunder constitute a separate 
legal proceeding, yet it can have no independent existence. 
The attachment is ancillary to, and dependent on, a principal 
proceeding, either in law or in equity, which has for its pur¬ 
pose a determination of the creditor’s demand. It is, there¬ 
fore, tantamount to an involuntary dispossession of the de¬ 
fendant prior to any adjudication of the rights of the plain¬ 
tiff—an execution, so to speak, in advance of trial and judg¬ 
ment. In other words, attachment is a provisional remedy 
for the collection of an ordinary debt whereby a preliminary 
levy upon the property of the debtor may be made in order to 
preserve it to the creditor until his lien shall have been per- 

316 


PROVISIONAL REMEDY OF ATTACHMENT 


317 


fected by judgment on a debt, for which suit has been or is 
about to be brought. In the latter case, suit must be brought 
within a certain time after service of the writ of attachment 
(usually 30 days). Otherwise, jurisdiction over the property 
attached ceases. 

Statutory Remedy 

Attachment is a remedy entirely statutory, concerning 
which each state has its own statutes, but, in so far as the 
general principles of the law of attachment are concerned, the 
statutes of the different states are in many respects uniform. 
Being a harsh legal remedy, the attachment statutes are strictly 
construed and the writ will be issued only in those cases in 
which it is explicitly allowed by statute. 

Kinds of Attachment 

There are two kinds of attachments: (1) domestic at¬ 

tachment is a proceeding against the property or credits of a 
resident debtor; (2) foreign attachment is a proceeding against 
the property or credits of a non-resident debtor. 

Suit Personal in Form but a Property Action in Substance 

The writ of attachment is always preceded or accompanied 
by a summons, which is either served on the defendant per¬ 
sonally or by publication. But the judgment in an attachment 
suit binds only the property attached, and not the debtor per¬ 
sonally. It therefore follows that a plaintiff who fails to 
sustain the ground of his attachment cannot succeed in his 
action against the defendant personally. 

However, it should not be inferred that the recovery of 
the plaintiff is restricted to the property attached, for while 
the property is held subject to such judgment as the plaintiff 
may recover, the judgment authorizes an execution also 
against other property of the debtor within the jurisdiction 
of the court, whether attached or not. 


318 rights and remedies OF CREDITORS 

Property Attached but No Personal Service 

If property is attached but no personal service of the sum¬ 
mons is obtained on the defendant, or he does not appear, he 
is notified by publication. This brings him before the court 
only, however, for the purpose of dealing with the property 
attached. In other words, where the defendant is a non¬ 
resident, and is notified only by publication, he is before the 
court for all purposes except the rendition of a personal judg¬ 
ment, so that the judgment under such circumstances binds 
only the property attached. 

The procedure in obtaining jurisdiction over absent defend¬ 
ants is governed by the statutes of the different states. The 
publication is generally intended as a substitute for personal 
service, and after proof of publication is made, both parties, 
so far as relates to appearance and pleading in court, stand in 
the same position as they would have occupied on the return 
of a summons personally served. 

If the plaintiff recovers judgment against the defendant 
without his appearance, such judgment will have no effect in 
another state as a personal judgment against the debtor (see 
pages 293-296). But if the defendant appears and defends 
himself in person or by attorney, the judgment will have the 
same force and effect everywhere as a judgment recovered in 
an ordinary suit. Furthermore, the plaintiff cannot take judg¬ 
ment for a greater amount than that for which the attachment 
was issued, nor for any other cause than that stated in the at¬ 
tachment. 

If no property is found to attach and there is no personal 
service on the defendant, or no appearance by him in the state, 
there is nothing to give the court jurisdiction, and a judgment 
against the defendant would under such circumstances be void. 

Debts or Accounts Not Due 

In the absence of statutory provision, .the debt, or account, 
must be due or the attachment cannot be sustained. In some 


PROVISIONAL REMEDY OF ATTACHMENT 


319 


states, however, an attachment is allowed on a debt not due, 
but under such statutes the debt must be an actual subsisting 
debt, which in time will become due. In other words, the 
statute does not apply to debts resting on a mere contingency 
as to whether they will ever become due to the attaching 
creditor or not. 

Who May Bring Attachment 

In general, any creditor is authorized to sue out an attach¬ 
ment. Where the remedy is given to a creditor, a creditor is 
one who has a right to require of another the fulfilment of a 
contract or obligation. Non-residents as well as residents may 
avail themselves of the writ of attachment, even where both 
parties are non-residents. A corporation, either foreign or 
domestic, as well as the individual person, may exercise the 
creditor’s right of attachment. 

Grounds for Attachment 

Ordinarily the mere inability of a debtor to pay his debts 
will not justify attaching his property. Attachment is based 
on the assumed indebtedness of property, and it authorizes 
procedure against it only where the personal debtor cannot be 
effectively reached by ordinary process. Attachment, being a 
purely statutory remedy, is available only where one or more 
of the grounds enumerated in the statute exist. The principal 
grounds for resorting to this extraordinary remedy are sub¬ 
stantially the same in all states, a few exceptional grounds 
existing in only a few states. These principal grounds are as 
follows: 


1. That the debtor is a non-resident of the state (not 

county) where the writ of attachment is sought 
against the debtor’s property located within the state. 

2 . That the debtor has departed from the state with intent 

to defraud creditors or to avoid service of legal pro¬ 
cess, 


3 20 


RIGHTS AND REMEDIES OF CREDITORS 


3. That the debtor with like intent keeps himself concealed 

within the state. 

4. That the debtor has removed property or is about to 

dispose of property for the purpose of defrauding 
his creditors. 

5. That the debtor has secured property from the creditor 

by fraudulent representations, such as the making of 
a false statement in writing regarding his financial 
condition. 1 

Absent Debtors 

Absence in the attachment law does not mean a mere tem¬ 
porary absence with intention to return. But an absence, even 
with an intention to return, is sufficient if it was taken to avoid 
proceedings by the creditor or naturally has that effect. One 
who removes to another state for purposes requiring his 
remaining there an indefinite time must be deemed a non¬ 
resident of the state he leaves for purposes of subjecting his 
property within the state to attachment, although he may intend 
to return in the remote future. 

Absconding Debtors 

An absconding debtor is one who hides, conceals, or absents 
himself from his usual place of abode with intent to avoid 
legal process. He need not go beyond the limits of the state. 
For example, a person who shuts himself up from his creditors 
has been held to be an absconding debtor. But one who leaves 
his abode without any fraudulent design, intending to return, 
is not an absconding debtor. An intention to abscond is not, 
in and of itself, sufficient; there must be an actual absconding, 
such as prevents service of process on the debtor. Whether 
a debtor has withdrawn himself from his creditors with intent 
to elude process to evade their demands is a question of fact 
to be submitted to the jury. 


1 For creditor’s right of attachment for violation of Bulk Sales Law, see Chapter XXIX. 



PROVISIONAL REMEDY OF ATTACHMENT 


3 21 


Debtors Concealing Themselves 

By this phrase is meant concealment by the debtor to avoid 
service of process with a view to defraud creditors, or for the 
purpose of gaining time in which to dispose of his property, 
lawfully or otherwise, before his creditors can gain access to 
him. It is the designedly placing of himself where his cred¬ 
itors cannot reach him with process, which constitutes the 
necessary concealment. 

For example, if a person going away tells his neighbors 
and friends where he is going, the mere fact that he does not 
so inform his creditor does not amount to concealment. But 
if, in leaving, he request false information to be given of his 
movements, this is concealment. In other words, the conceal¬ 
ment, to justify an attachment, must be to avoid or delay claims 
of creditors, and the debtor must also actually conceal himself 
to such an extent that he cannot be served with process. 

Non-Resident Debtors 

In all the states the fact that the debtor is a non-resident 
of the state is a good ground for an attachment against his 
property. Non-residence in the county in which the action is 
brought is not usually a ground of attachment. A person once 
acquiring a residence in a place does not lose it by going out 
of the state unless such removal is also accompanied by the 
intention to make such new place his home. A change of 
abode with the intention of not returning, however, makes one 
immediately a non-resident of the place from whence he parted. 
That a person has a place of business in the state and remains 
there during business hours, does not make him a resident if 
he lives outside the state. If he is a non-resident, the fact 
that he is at the time of the attachment temporarily in the 
state does not affect the validity of the attachment. 

Once attachment proceedings have been instituted, an at¬ 
tachment against a non-resident will not be set aside on the 
ground that the defendant has since become a resident. 


RIGHTS AND REMEDIES OF CREDITORS 


3 22 

Removing Property from State 

Where a statute authorizes attachment “where the debtor 
is about to remove his property from the state,” it must appear 
that the property is of such a character that its removal out 
of the state is beyond its ordinary and customary use. Thus, 
the shipping of goods by the debtor to a creditor in another 
state in payment of a bona fide debt, or in the usual course of 
business, and without fraudulent intent is not a removal within 
the meaning of the statute. Furthermore, the mere fact that 
the defendant is removing part of his property is no ground 
for attachment if he has left, or intends to leave, sufficient 
other property to satisfy the debt. Nor does the taking of 
property out of the state for a mere temporary purpose, intend¬ 
ing to bring it back, constitute a removal within the meaning 
of the statute. 

However, to sustain the issue of the defendant being about 
to remove his property, it is not necessary to show that he is 
doing so with fraudulent intent, unless the statute so specifically 
provides. If the purpose to remove exists and the object is 
to evade or delay creditors, the writ may issue. 

Concealing or Disposing of Property 

“Disposing” of the property means any kind of alienation 
of it, whether by sale, gift, pledge, assignment, or other trans¬ 
fer. But a dealer’s daily selling of his goods in the regular 
course of business is not within the statute, nor a mere threat 
of a debtor to make a preferential assignment. 

It is not necessary to show that the defendant was about to 
dispose of all his property; the attachment will be sustained 
if it be shown that he was about to dispose of any part of it 
for the purpose of defrauding his creditors. An intent to 
defraud his creditors is essential, but fraud may, and will, be 
presumed where the defendant while in debt is about to put his 
property out of his hands, without consideration. It is not 
essential, in order to obtain an attachment, on the ground that 


PROVISIONAL REMEDY OF ATTACHMENT 


323 


the debtor has fraudulently transferred or disposed of prop¬ 
erty, that the debtor be insolvent, although where he is not, 
it must be shown that a material portion of his property has 
passed. 

It is not ordinarily considered a fraudulent transfer justi¬ 
fying attachment for a creditor to prefer one creditor over 
others, whether this is done by way of absolute conveyance of 
property in liquidation of the debt, by confessing a judgment 
in the creditor’s favor, by way of mortgage to secure payment, 
or by way of actual payment of the debt. Under some statutes, 
however, a mere preference of one creditor over another is 
ground for attachment. 

Property Subject to Attachment—Personal Property 

As the sole object and aim of an attachment is to acquire 
and hold a lien upon property until it can be finally taken on 
execution, it follows that only such property should be attached 
as can be lawfully made subject to execution. In other words, 
the anticipatory levy by attachment should be governed by the 
rules applicable to the final levy under execution. In one 
respect, however, an attachment goes still further than an exe¬ 
cution; it extends beyond the tangible property to which the 
latter is confined and seizes the accounts due to and property 
held for the debtor. But in respect to tangible property, real 
and personal, in the possession of the debtor, the rule is general 
that an attachment will affect such property, and such only, 
as may be levied upon and sold under execution. The test, 
therefore, as to whether certain personal property may be levied 
upon and sold under execution is—could the debtor legally 
transfer title to such property? 

Choses in Action 

Choses in action were not susceptible to levy at common 
law, due to the fact that, with the exception of negotiable 
instruments, they were not transferable so as to give the 


3 2 4 


RIGHTS AND REMEDIES OF CREDITORS 


assignee a right to sue thereon in his own name. 1 his prin¬ 
ciple, however, has been so modified by statute in many of the 
states as to include choses in action wichin the meaning of the 
term “personal property.” 

Levy upon Interest in Shares or Bonds 

The rights or shares which the defendant has in the stock 
of an association or corporation, or in a bond, negotiable or 
otherwise, together with the profits and interest therein, may 
be levied upon; and the sheriff’s certificate of the sale thereof 
entitles the purchaser to the same rights and privileges with 
respect thereto which the defendant had when they were*. so 
attached. 2 

Equitable Interests 

The common law rule was that nothing but legal titles could 
be made the subject of a levy. Consequently, the sheriff being 
required to make a manual seizure of the property, no levy 
could be made unless both the legal and equitable title were in 
the debtor. This rule still applies in the absence of special 
statutory provisions recognizing the right of levy upon equi¬ 
table interests only. The rule is founded upon the theory that 
an attachment or execution, being based upon an action at law, 
should be restricted to legal interests. But where an equitable 
interest in personal property is combined with the possession 
and the right to hold it for a certain time, the interest is a 
leviable one, even in states holding the strict common law 
rule. 

Property Covered by a Chattel Mortgage 

It is this last-noted distinction that makes the equitable 
interest of a mortgagor of chattels chargeable by levy so long 
as he retains an absolute right of possession. But the interest 
of a mortgagor of chattels, being a purely equitable right to 


2 For example, see Section 915, Civil Practice Act of New York. 



PROVISIONAL REMEDY OF ATTACHMENT 


32 5 

redeem, is not attachable unless the mortgage expressly gives 
him the right of possession. 8 

As regards the interest of the mortgagee, he has a leviable 
interest just as soon as the mortgagor has lost such interest. 
It cannot be owned by both at the same time; neither is there 
any period when it is not owned by either of them. Hence the 
rule being fixed that the right of levy shifts with the leviable 
ownership, inasmuch as the main object in a levy is to secure 
the immediate right of possession. 

Property Pledged as Collateral Security 

This rule as to the necessity of an absolute right of posses¬ 
sion to constitute a leviable interest, operates to shield from 
attachment goods pledged for the security of a debt. Whereas 
the legal title in such cases is in the pledgor, he labors under 
the same disadvantage as a mortgagee who by virtue of the 
mortgage acquires the legal title, but is without the right of 
possession until the mortgagor is in default. 

In several of the states this disability has been overcome 
by special legislation authorizing an attachment of such prop¬ 
erty, incapable of manual delivery, in the hands of the debtor. 
This extends the right to the interest of the mortgagor, pledgor, 
0 1 * consignor of goods, and constitutes an exception where a 
levy can be made upon the interest of a person in certain 
property but not upon the property itself. 

Conditional Sales 

The same principle applies to conditional sales where a con¬ 
dition precedent, namely, payment for the goods, prevents and 
delays the temporary passing of the legal title to the purchaser. 
In all such cases the purchaser does not take such a title to the 
property as to subject it to an attachment for his personal 
liabilities. The question then arises whether in such cases the 
goods may be attached in an action against the seller. On this 


3 35 N. Y. 274. 



326 RIGHTS AND REMEDIES OF CREDITORS 

point the well-founded principle has been laid down that inas¬ 
much as property cannot be so placed as to shield it from the 
creditors of both parties to the transaction, it is inconceivable 
that the seller in such cases does not retain a leviable interest 
until such is acquired by the purchaser. 

This subject is now dealt with in most states by special 
statutes. 

Goods Sold but Retained in Possession of Seller 

It is a debatable question as to how far the purchaser of 
goods which have not been actually delivered is to be protected 
against attaching creditors of the seller. If the goods remain 
in the possession of the seller after the sale, the attachment 
is generally held good, because the purchaser has allowed the 
seller to appear to be the absolute owner and the attaching 
creditor has a right to regard him as such unless he has a notice 
to the contrary. 

The division of opinion on the issue involved, however, 
is well illustrated by the following two cases: 

Plaintiff, an indorser on a note made by a shoe company, 
bought from the company a lot of goods in return for a prom¬ 
ise to assume the note. The company was allowed to keep 
possession of the goods. Later it became insolvent. Plaintiff 
was allowed to recover against the assignee. 4 

A silk company executed a bill of sale of goods to a bank 
as security for indebtedness, but retained possession of the 
goods. Creditors of the company subsequently attached the 
goods. Court held that the conveyance to the bank was con¬ 
clusively presumed to be fraudulent since the debtor retained 
possession. 5 

Fixtures 

Fixtures are chattels that have become affixed to the realty. 
They may be subdivided into “movable” and “immovable” 


4 22 S. E. Rep. 492. 
6 92 Fed. Rep. 274. 



PROVISIONAL REMEDY OF ATTACHMENT 


327 

fixtures. The former are personalty; the latter are realty. 

The best general rule that can be adopted as to what prop¬ 
erty in the nature of fixtures can be attached as personalty, is 
that wherever the debtor has by law the right of sale and 
removal of the property, that right can be transferred to and 
exercised by a purchaser at a sheriff’s sale and is therefore 
leviable under attachment and execution. 

Immovable fixtures, being part of the realty, cannot be 
separately attached, but will pass under a levy upon the realty 
to which the fixtures are annexed. To become a part of the 
realty, there must be such an annexation as to render removal 
impossible without working a substantial injury to the free¬ 
hold. 

Real Estate—Prerequisites to Levy 

Although personal property is primarily liable for the pay¬ 
ment of debts, real estate may be levied upon in the absence 
of sufficient personalty to secure the creditor’s claim. Under 
the statutes of some of the states a formal indorsement of the 
failure to levy upon sufficient personalty to secure the writ must 
be made thereon before attaching the realty. The mere fact 
that it is later shown that the debtor did possess sufficient 
personalty to secure the claim will not nullify the attachment 
on the real estate. It has even been held that the defendant, 
in order to raise objections on this ground, must, prior to the 
levy thereon, specifically designate personal property sufficient 
to cover the writ; and if the property is shown to be practically 
valueless, or so covered with mortgages as to be rendered unsal¬ 
able, the sheriff may overlook it entirely and proceed at once 
against the debtor’s landed interests. 

Attachable Interests in Real Estate 

The term “real estate” as used in the statutes affecting the 
attachment of realty includes all interests in lands, tenements 
and hereditaments, greater than that of a lease for years. 


RIGHTS AND REMEDIES OF CREDITORS 


3 28 

Interest of a Mortgagor 

At common law a mortgage, which is nothing other than 
a deed or conveyance containing a defeasance clause, trans¬ 
ferred title to the realty from the mortgagor to the mortgagee. 
Under the present-day doctrine, however, the mortgagor con¬ 
tinues to be the owner of the estate until after the delivery 
of the deed under foreclosure proceedings. The mortgage, 
therefore, is a mere lien for the payment of a debt and as such 
is personal property. The mortgagee not having any estate 
in the property itself, it necessarily follows that the mortgagor’s 
interest, the so-called “equity of redemption,” is real estate and 
attachable as such. 

Absolute Transfer as a Mortgage 

A deed absolute on its face, but given as security for a 
debt, is in equity a mortgage; but the difference between such 
a deed and the ordinary mortgage, so far as creditors are con¬ 
cerned, is this: The deed transfers the legal title to the grantee, 
whereas the mortgage does not. In such a case the grantor’s 
resulting interest has been considered a mere equitable interest 
to the extent that it cannot be levied upon as real estate. 

Interest of a Mortgagee 

Being a mere lien given as security for the payment of a 
debt and collateral to the principal obligation, the interest of a 
mortgagee is personalty and can only be attached as a chose 
in action. In other words, a levy cannot be made thereon as 
real estate. 

Effect of a Levy upon Realty 

Bearing in mind that the purpose of all attachment proceed¬ 
ings is to create and enforce a lien, the sole effect of the levy 
of an attachment upon real estate is to create a lien. It creates 
no interest in the property itself in favor of the attaching 
creditor. For this reason it creates no right to enter upon the 


PROVISIONAL REMEDY OF ATTACHMENT 


3 2 9 


possession of the property, even for the purpose of improving 
or preserving its value; neither does it permit the attaching 
party to receive the rents or other profits therefrom. It is 
nothing more than a conditional claim to take effect in the 
future, provided the action shall proceed to judgment in favor 
of the creditor, or plaintiff. 

Statutory Exemptions 

Practically every state in the Union has a law exempting 
certain property from attachment. These exemptions have 
already been set forth (see pages 287-293). 

Attachment Procedure 

Having considered: (1) the nature of the creditor’s right 
of attachment, and (2) the property of the debtor that is sus¬ 
ceptible to the exercise of this right, we come now to (3) the 
enforcement of this right in the manner provided by law. 
Although the different states have separate statutes governing 
the right of attachment, the general principles applicable to its 
enforcement are also substantially alike. 

When an attachment issues in a case pending in court, this 
auxiliary process must issue from and be returnable to the court 
in which such suit is pending. 

Necessity and Nature of Affidavit 

Most statutes require as a preliminary to the issuance of a 
writ of attachment that the plaintiff or creditor make an affi¬ 
davit (Form 17) stating that one or more of the statutory 
grounds for the issue of a writ exist. Consequently, if there 
be no affidavit, or one with a total absence of the special 
grounds prescribed by law as essential to the issue of a writ, 
the writ so issued will be without legal jurisdiction and all 
subsequent proceedings, should there be any, would be void. 

The affidavit may, however, contain the additional requi¬ 
sites of the complaint of the plaintiff, so as to dispense with 


330 


RIGHTS AND REMEDIES OF CREDITORS 


Affidavit for Attachment of Goods 


State of. Ohio . 

County of .. . .Hamilton 

. James Ballard 

vs. 



In the .. Circuit .. Court of Hamilton 
County. 

.. November. . Term, 192 — 


. Paul Reece . 

James Ballard .. being duly sworn, deposes and says that .. Paul Reece .. 
is indebted to him the said .. James Ballard. ., after allowing all just credits 
and set-offs, in the sum of .. Ninety. . dollars, for goods sold and delivered 
to said .. Paul Reece .. at his request, and that the said .. James Ballard .., 
(any one or more of the following grounds may be alleged) 

(1) is not a resident of this State; . 

(2) conceals himself and stands in defiance of an officer so that process can not 

be served upon him; ... :*•••.. 

(3) has departed from this State with the intention of having his effects removed 

from this State; .•.••••:. ; •. 

(4) is about to remove from this State with the intention of having his effects 

removed from this State; .. ... 

(5) is about to remove his property from this State to the injury of the said 

plaintiff; ... # .. 

(6) has within two years preceding the filing of this affidavit fraudulently con¬ 
veyed {or assigned ) his effects so as to hinder or delay his creditors; .. 

(7) has within two years prior to the filing of this affidavit fraudulently concealed 

{or disposed of) his property and effects so as to hinder or delay his credi¬ 
tors; ... 

{8 ) is about to conceal , assign , and otherwise dispose of his property and effects , 

so as to hinder and delay his creditors; . 

{9) contracted the said debt fraudulently . 

And affiant further says that the place of residence of said . . Paul Reece. . 
is . . Cincinnati , Ohio. ., (or that upon diligent inquiry affiant has been unable 
to ascertain the place of residence of said . . Paul Reece . . ) . 

Subscribed and Sworn to before me this .. 10th.. day of .. November .., 


192—.. 


. A ndrew Hudson . 

Clerk .. Circuit .. Court of .. Hamilton .. County 


Form 17. Affidavit for Attachment of Goods 


the necessity and inconvenience of preparing and filing any 
separate complaint as the basis of the creditor’s suit. 


Who May Make Affidavit 

The affidavit may be made by the creditor, his agent, or 
attorney. In an affidavit made by an agent or attorney for the 
plaintiff, the affiant must describe himself as such, and state 
in the affidavit that he makes it on behalf of the plaintiff. Nor 
need he disclose his means of knowledge. But the affidavit 
must state the grounds for the attachment positively, though 
the amount set forth in the claim may be stated to be correct 





















PROVISIONAL REMEDY OF ATTACHMENT 


331 


“to the best of his knowledge and belief.” The affidavit may 
be taken before any officer authorized to administer oaths. 

Form of Affidavit 

The affidavit should set forth: (1) the cause of action, or 
the indebtedness of the defendant, and (2) the existence of 
one or more of the special grounds for attachment. The fol¬ 
lowing statements as to the claim and indebtedness have been 
held essential to the validity of the affidavit: 

1. The amount of the indebtedness. 

2. That the claim is just. 

3. That no part of the debt has been paid. 

4. The nature of the indebtedness, i.e., manner in which 

the debt accrued. 

5. That he is not indebted to the defendant. 

6. That the sum demanded is actually due. 

7. The statutory ground for attachment. 

The affidavit must follow and comply in all respects to the 
statutory requirements, and where a special form is prescribed 
by statute, it should be followed. But in any event the infor¬ 
mation set forth in the affidavit must be stated as matters of 
fact, and the affidavit is defective if, instead of stating neces¬ 
sary facts, it states merely inferences or conclusions of law. 

Several Grounds Alleged in One Affidavit 

The creditor, or plaintiff, may allege any number of 
grounds of attachment he pleases, and if any one of them is 
proved it will suffice to support the writ, though the others are 
disproved or not properly sustained. But the statement of 
two grounds of attachment in the alternative is bad, such as 
that the defendant “has assigned, or is about to assign his 
property,” or that he “has transferred or secreted his prop¬ 
erty.” Where, however, the disjunctive “or” is used to char¬ 
acterize and connect two distinct phases of the same act, and 


332 


RIGHTS AND REMEDIES OF CREDITORS 


not to connect two distinct facts of an altogether different 
nature, such as that the defendant “is indebted to said plaintiff 
or has in his hands effects of said plaintiff,” the affidavit is 
good. 

When to be Made and Filed 

The affidavit may be made a reasonable time before the 
writ is issued; it need not be made on the very day, unless so 
required by statute. Likewise, it may be filed within a reason¬ 
able time after it is made. 

How to Object to Faulty Affidavit 

The most common method of objecting to an attachment 
on the ground that it is faulty or defective is by a motion to 
quash, or to vacate the attachment. 

Waiver of Defects in Affidavit 

By appearing and answering, the defendant waives defects 
in the preliminary proceedings. But appearing merely to move 
for the dismissal of the attachment does not waive the pre¬ 
liminary defects. 

Defects May be Amended 

In many states the statutes provide that a defective affidavit 
may be amended or a new one filed. And in such states a 
motion to amend may be granted, even after a motion has been 
made to vacate the attachment because of the defect. 

The Attachment Bond 

As a further preliminary, or condition precedent to the 
issuance of the writ of attachment, practically all the state 
statutes require the giving of a bond, or undertaking, by the 
plaintiff, with sufficient sureties, to the effect that if the defend¬ 
ant recovers judgment, or if the warrant is vacated, the plaintiff 
will pay all costs which may be awarded to the defendant, and 


PROVISIONAL REMEDY OF ATTACHMENT 


333 

all damages which he may sustain by reason of the attachment, 
not exceeding the sum stipulated in the bond. 

The bond usually provides for the payment of costs and 
damages to the defendant if the attachment has been “wrong¬ 
fully issued or obtained.” Under this phrase a mere failure 
to prosecute the attachment suit does not give rise to an action 
on the bond, nor the failure of the suit on technical grounds. 
Furthermore, if the plaintiff had good cause to believe the 
grounds for attachment true, the attachment is not wrongful. 
On the other hand, it has been held that an attachment sued out 
on a ground which did not exist, is wrongful, without regard 
to the belief of the person making the affidavit. 

Burden of Proof 

In such proceedings there is a presumption that the attach¬ 
ment was rightfully sued out, and in an action on the bond 
the burden of proof is on the defendant in the attachment suit 
to prove that it was wrongful. Where the defendant succeeds 
in his action on the bond, he is entitled to recover for the actual 
damages he has suffered as the natural result of the wrongful 
suing out of the writ. Such actual damages consist of: 

1. Expense and losses incurred in making his defense to 

the attachment proceedings. 

2. Loss occasioned by his being deprived of the use of his 

property during the pendency of the suit. 

3. Effect of the attachment upon his credit standing. 

Remote and speculative damages resulting from injury to 
his credit standing, business, or character cannot be recovered. 

The Writ 

The writ of attachment is nothing more than a formal 
order from the court to the sheriff to execute the same 
against the defendant’s property. 

The writ must follow the requirements of the statute and 


334 


RIGHTS AND REMEDIES OF CREDITORS 


it is analogous to a writ of execution, except that it emanates 
at the beginning instead of the termination of a suit. It must 
be under the seal of the court. It should also contain such 
material requisites as the nature of the action pending, the 
names of the respective parties to the suit, and the grounds 
upon which the court bases its authority to issue the writ. 

The Levy 

The sheriff to whom the writ or warrant is directed and 
delivered should immediately proceed to execute it in the man¬ 
ner therein prescribed, by attaching so much of the defendant’s 
property, not exempt from levy, as will satisfy the plaintiff’s 
demand, together with costs and expenses. Should the original 
levy prove insufficient he may levy from time to time and as 
often as it is necessary, until the amount for which it was 
issued has been secured. In fact, it is the duty of the officer 
on receiving a writ of attachment to execute it as soon as he 
reasonably can, and it has been held that if property is lost 
that otherwise might have been levied upon, due to any negli¬ 
gence on his part, he may be held liable for the damage 
resulting. Nor is it a sufficient excuse in such a case that the 
plaintiff failed to state that urgency was desired. The warrant 
itself usually specifies that fact, and such is the sheriff’s duty 
independent of special instruction. 

The test that has been laid down is this: Did the defendant 
have property concerning which the officer, by the exercise of 
reasonable diligence, could have learned, and upon which a 
seizure could have been made? No doubt a prudent creditor 
would, on delivering the writ to the officer, take pains to inform 
him where property subject to the writ could be found, and 
would co-operate with the officers in their attempt to execute 
the writ. But the plaintiff is not bound to pursue this course. 
He need only place the writ in the officer’s hands for service. 
The officer must then make reasonable search and inquiry; 
and if such search and inquiry would have discovered prop- 


PROVISIONAL REMEDY OF ATTACHMENT 


335 


erty, his omission cannot be excused by showing that the 
plaintiff neglected to point out anything upon which a levy 
could be made. Mere possession of personal property is prima 
facie evidence of ownership, and wherever it is shown that the 
sheriff had knowledge that the defendant was possessed of 
personal property, and he fails to levy upon it, the burden 
of proof falls upon him to show that the property was not 
subject to execution. 

On the other hand, an officer is a trespasser who levies on 
property not subject to attachment. For example, an officer 
about to levy on personal property is bound by actual notice 
of a prior mortgage. Where the property is mixed with other 
property of the same kind belonging to a third party, so that 
it cannot be distinguished, the officer, in attaching the whole 
of it, is not liable for trespass, and it becomes the duty of the 
third party to claim and demand his portion from the officer. 
An officer may effect a forcible entry into a store or warehouse 
to attach property there, i.e., stock certificates, bonds, merchan¬ 
dise, etc., but he cannot force his way into a dwelling house 
against the will of the owner. 

Manner of Making Levy 

Personal Property. To constitute a good levy on per¬ 
sonal property under an attachment, the officer must actually 
reduce it into his possession to such an extent that it cannot 
be withdrawn or taken by another without his knowing it. 
This rule applies likewise to promissory notes and bonds. 

Where, however, the property is of an intangible nature 
and not susceptible of delivery (a chose in action), levy is 
made by serving upon the debtor a certified copy of the warrant 
of attachment together with a notice of the property thus at¬ 
tached. Levy can generally be made upon shares of stock in 
a foreign corporation, provided the certificates are within the 
state; if not, the levy cannot be made because it is necessary 
for the sheriff to obtain actual possession of the certificates. 


336 


RIGHTS AND REMEDIES OF CREDITORS 


In the case of shares in a domestic corporation, however, 
when a levy upon the certificates cannot be made by the sheriff, 
it may be effected by the sheriff delivering, or serving, a certi¬ 
fied copy of the warrant, together with a notice of the shares 
attached, upon an officer of the corporation. If the corporation 
refuses to recognize the attachment, application should be made 
to the court for aid in effecting the levy. 

Levy can be made on a note or chose in action only when 
and so long as the debtor or defendant has an interest in or 
title thereto. Consequently, a sheriff cannot levy on a note or 
chose in action which has been transferred to a bona fide pur¬ 
chaser for value but with the intent to defraud his creditors. 
It is still a chose in action, and when legal title is thus trans¬ 
ferred to a third party it is no longer in the debtor and there¬ 
fore cannot be attached as his property. In other words, a 
promissory note or chose in action which has been transferred 
in fraud of creditors cannot be attached by the sheriff. 6 

The rule with respect to other goods and chattels is differ¬ 
ent, however, in that goods and chattels which have been 
fraudulently assigned by a debtor to hinder, delay, and defraud 
his creditors are attachable in the hands of the fraudulent 
transferee in the suit of a creditor defrauded by the transfer. 7 

Therefore, a distinction must be made between a levy on 
choses in action and promissory notes which are fraudulently 
transferred, and a levy on goods and chattels other than choses 
in action and promissory notes, when fraudulently conveyed. 
In the case of the latter a valid levy may be made, provided, 
of course, that the transferee is not a bona fide purchaser for 
value. 

As for heavy and bulky articles, or where the removal of 
the property attached would be attended with great waste and 
expense, the actual handling of the property may be dispensed 
with. In such instances the mode of procedure is to serve the 


6 96 N. Y. 180. 

7 117 N. Y. 306. 



PROVISIONAL REMEDY OF ATTACHMENT 


337 


proper person or officer of the corporation with a certified 
copy of the writ and notice that the property has been levied 
upon. 

Real Property. To attach real estate, the officer need not 
go upon the land or even see it. It is sufficient for him to file 
a notice of attachment in the office of the county clerk, wherein 
the property lies, and to make a formal return on the writ that 
he has attached it. In fact he has no right to take actual 
possession of the land or to disturb the possession of the owner 
or occupant. 

The Return 

The officer having levied the attachment, it is his duty to 
make a return or formal report of it on or before a given time 
specified in the writ by the court and called the “return day.” 
Otherwise the attachment will be dissolved. The formal return 

i 

must set forth what action was taken, by whom, and how ac¬ 
complished, together with the names of the parties in whose 
presence the writ was served. The officer must include in his 
return a specific description of the property attached, its kind, 
quantity, number, size, etc., as the case may be. 

Lien Dates from Levy 

The lien of an attachment does not date or take effect from 
the date of issue of the writ, but from the time of its actual 
execution, whereupon the attaching creditor acquires the right 
of the defendant in the property at the time the attachment took 
place. No interest subsequently acquired by the debtor in the 
property is affected. And, likewise, a previous assignment of 
the property is valid against a subsequent attachment. 

The levy of an attachment is not a satisfaction of the plain¬ 
tiff’s demand; nor does the attachment transfer or change the 
ownership of the property, or take away his power of alienation 
subject to the creditor’s lien thereon. Property seized under 
attachment practically amounts to nothing more than a legal 


RIGHTS AND REMEDIES OF CREDITORS 


338 

deposit in the hands of the sheriff pending termination of the 
action. 

Lien Consummated by Judgment 

The lien of the attachment is consummated, or made abso¬ 
lute, by judgment. Where lands of the defendant are attached 
and judgment is later rendered against him, the lien of the 
judgment will revert back and take effect as of the date of the 
attachment. If judgment be given for the defendant, the lien 
is thereby destroyed. 

Successive Attachments on Same Property 

Where there are several attachments against the same prop¬ 
erty, they are entitled to satisfaction in the order of their time 
of service, the second being entitled to the surplus left after 
satisfying the first, and so on. Where several attachments are 
simultaneously served on the same property, the proceeds de¬ 
rived from a sale of the property is prorated or distributed 
between all, each being entitled to an aliquot part. 

Officer Must Hold Property 

The duty of the officer after he has attached property is to 
retain possession of it. If he surrenders possession of it to 
anyone, he will be considered as having abandoned the attach¬ 
ment, and the creditor’s lien will be lost. He may, however, at 
his discretion, release it upon the claim of a third party that he 
is the rightful owner, but the officer does so at his peril. He 
has no right to deliver it to the plaintiff. Neither has he any 
right to allow the property to remain in the possession of the 
defendant, or constitute the defendant his agent to keep the 
property for him. But possession of the goods attached need 
not be personal; he may place the property in the custody of a 
servant or agent, not the debtor, and the subsequent use by the 
debtor of such article does not affect any rights acquired by 
the attachment. 


PROVISIONAL REMEDY OF ATTACHMENT 


339 


Dissolution or Vacation of the Attachment 

In most states the -attachment may be dissolved by the 
defendant giving a bond for the payment of such judgment as 
may be rendered against him. The acceptance of such bond 
releases the lien on the property. If the legal possession of the 
attached goods and chattels is lost, the attachment which is 
dependent upon such possession is ipso facto dissolved. But 
the mere removal of the property from the state by the person 
appointed to keep it in possession does not work a dissolution of 
the attachment. 

Insolvency or Bankruptcy 

A creditor’s knowledge of the insolvency of his debtor is 
not sufficient to prevent him from obtaining a valid lien by 
attachment of the debtor’s property, nor will a decree of insol¬ 
vency against a debtor by the court of another state work a 
dissolution of an attachment of his property within the state. 
Furthermore, an attachment in a foreign state is not dissolved 
by a subsequent general assignment for the benefit of creditors 
in the debtor’s state of residence. 

If an attachment is levied more than four months prior to 
the filing of a petition in bankruptcy by or against the debtor, 
the lien of attachment is preserved by the federal Bankruptcy 
Act. Otherwise the attachment is dissolved by the Bankruptcy 
Law. But a dissolution of the attachment resulting from pro¬ 
ceedings in bankruptcy will not defeat an action on the bond 
of indemnity, inasmuch as the bond, in such cases, operates a 
complete conversion and substitution for the property. 

Death of the Defendant 

In a personal action, the death of the defendant before 
final judgment abates the action and dissolves the attachment. 
But an attachment is not dissolved by the death of the debtor 
after judgment but before the property has been disposed of 
under execution. In some states, where the statute provides 


340 


RIGHTS AND REMEDIES OF CREDITORS 


that an attachment is not dissolved by death, it is necessary to 
revive the action against his personal representative in order to 
preserve the lien. This may usually be accomplished by a 
motion addressed to the court. When the attachment is dis¬ 
solved it is the duty of the officer at once to redeliver the 
property to the defendant, but not necessarily to the place from 
whence he removed it. 


CHAPTER XXVII 


THE PROVISIONAL REMEDY OF GARNISHMENT 
Illustration 

The technical term of “garnishment” is derived from the 
French verb garnir, which means to give notice, or to warn. 

The right of attachment, as was explained in the preceding 
chapter, is nothing more nor less than the right of a creditor 
to seize property in the possession of the debtor and have it 
applied in satisfaction of his claim or debt. But suppose you 
have this situation to deal with: You have a judgment for 
$500 against a debtor who is found to be execution-proof; but 
it later develops that in closing out his business, and in order 
to divest himself of all assets that could be attached by 
creditors, he loaned $1,000 to B. The debtor himself, it is 
assumed, has nothing of a tangible nature upon which you can 
levy an attachment, but he has a right to demand and receive 
the repayment of his loan to B, which right is worth $1,000. 
Consequently, if you could attach that right, have the money 
paid into court by B, and then applied in satisfaction of your 
judgment, your claim would be paid. 

That, in brief, is the precise nature of this second pro¬ 
visional right of creditors—called the right of “garnishment,” 
and as for its relative importance as a creditor’s legal remedy, 
it has been said that for every payment that is enforced by 
attachment, twenty are collected by garnishment. In other 
words, where property has been transferred for the purpose of 
defrauding creditors, the creditors may, in many jurisdictions, 
hold the transferee liable as trustee to account for the property 
or its proceeds. It likewise applies to any case where a third 


34i 


342 


RIGHTS AND REMEDIES OF CREDITORS 


party has in his hands any funds or property belonging to the 
debtor. But, like the right of attachment, the right of garnish¬ 
ment is essentially a statutory remedy, and its scope and 
application is governed entirely by the statutes of each state. 

Definition 

The term “garnishment” is applied to a proceeding or 
process in the nature of attachment whereby the property, 
money, or credits of one person, generally called the “debtor,” 
and in the possession of or owing by another, generally desig¬ 
nated the “garnishee,” are applied to the payment of the debt 
of the debtor by means of process issuing against the debtor 
and the garnishee. 

The person instituting the proceedings is generally referred 
to as the “creditor” or “plaintiff”; the person indebted to the 
creditor is called the “debtor” or “defendant”; and the person 
in possession of the property sought and who is indebted to the 
debtor is called the “garnishee” (or “trustee”), or the one 
garnished, or warned (Form 18), by the creditor not to settle 
with the debtor but to answer to the suit of the creditor. 

In some states the term “trustee process” and also “third 
party proceedings” are used to designate that which in most 
states is called “process of garnishment.” 

Nature of Garnishment 

Garnishment, as a matter of formal procedure, is a suit 
whereby the plaintiff acquires a lien on the debt due from the 
garnishee to the defendant. It is not a new suit but always 
ancillary to the main action under which it is prosecuted. As a 
matter of substance, however, there is no real lien acquired, but 
rather a right to hold the garnishee personally liable for the 
debt, and to restrain the garnishee from paying the debt to 
the defendant. 

A garnishee is regarded as an innocent person owing 
money, or having in his possession property of another without 


PROVISIONAL REMEDY OF GARNISHMENT 


343 

Summons, Order of Attachment, and Notice to Garnishee, for Ten 

Per Cent of Personal Earnings 


The State of Ohio, . County, ss. 

To Any Constable of.Township: 


You are hereby commanded to summon .to appear 

before me, the undersigned, a Justice of the Peace of said County, at my office, 

in.Township, in said County, on the.day of. 

., A. D. 19.. .., at .... o’clock, .. M., to answer the action of 

..who claim of the defendant the sum of $. 

with interest thereon at.per cent from the .day of. 

., A. D. 19...., for necessaries 1 .furnished said 

defendant and his family, to-wit : 2 . 


The plaintiff asks judgment for the amount indorsed hereon , and for costs. 

You are also commanded to attach the excess above ninety per centum of 

the personal earnings of the defendant, now due him from. 

. hereby made garnishee in this action, 

in a sum sufficient to cover the above claim, and the sum of two dollars and 
fifty cents, cost. 

You are also commanded to notify said . 

garnishee, also to appear before me at the time and place above specified, and 

answer under oath or affirmation all questions put to .touching such 

personal earnings of the defendant, and to disclose truly the amount thereof 

that may be owing by.to the defendant, whether then due or not; and 

further to notify said garnishee that.is held liable to the plaintiff in 

this action, for the excess over and above ninety per centum of such personal 
earnings of the defendant, that is now due, and that shall become due from 
.to the defendant, from the date hereof until the final trial and adjust¬ 
ment of the cause for which this action is brought; and, in addition thereto, a 
sum not exceeding two dollars and fifty cents, to cover the actual costs of this 
proceeding. 

You will make due return on this writ, on the.day of.. 

A. D. 19.... 

Witness my hand, this.day of.. 19.... 

.Justice of the Peace 

1. If so, here write “work and labor,” and erase the preceding word, “necessaries.” 

2. “Groceries [or provisions, or clothing, or whatever other necessaries] furnished the defendant 

or his family,” or “For.days” labor, from.. 19. ., to.. 19. performed 

for said defendant at his request,” or similarly, as facts may be. As to costs, etc., see §10271 

(103 O. L. 567). 

Form 18. Notice of Garnishment 

fault or blame, and he is supposed to stand indifferent as to 
who shall receive the money or property. The garnishee in the 
eyes of the law is a mere stakeholder or custodian of property 
attached in his hands, and has no right to do any voluntary act 
to the prejudice of either the plaintiff or defendant in the 
action. Consequently, the effect of service upon the garnishee 
is to impound the funds in his hands. 

If the garnishee transfers during the pendency of the 
garnishment proceedings, any of the property or funds in his 
hands belonging to the principal debtor, he does so at his peril 

































344 


RIGHTS AND REMEDIES OF CREDITORS 


and is in no wise relieved from liability to the creditor by such 
conduct, even though it may have been induced by a mistaken 
idea as to the effect of the writ. However, payment to the 
debtor before the commencement of garnishment proceedings 
is proper, even though the future garnishee knew when he 
made the payment that the creditor was preparing to institute 
proceedings. 

Garnishment process operates only upon such interests of 
the debtor as exist at the time it is served, and not such as may 
afterwards arise, according to the statutes and decisions in 
most states. Consequently, if there is no indebtedness at that 
time from the garnishee to the defendant, the plaintiff will not 
be entitled to judgment, although it may appear that between 
the time of service and answer the garnishee became indebted 
and paid the debt to the defendant debtor. 

Persons Subject to Garnishment 

A question whicn often arises is as to whether or not a 
citizen in one state may garnishee a debt due and payable in 
another, and if so as to the proper jurisdiction in which to 
stage the proceedings. A non-resident cannot be garnisheed 
unless at the time he has in that state property of the defendant 
in his hands, or he is bound to pay the defendant money or 
deliver him goods within the state. This exemption likewise 
applies to a foreign corporation, except a foreign company 
either doing or qualified to do business in the state. 

A corporation is liable to the process like a natural person. 
However, a corporation cannot be garnisheed merely on 
evidence that the debtor has been doing work for it, and that 
the books disclose an unpaid balance in his favor. It must also 
appear that the balance has become an actual debt against the 
corporation, and whether the claim still belongs to the debtor, 
or has been assigned to some other person. 

In the absence of statutory permission an administrator 
cannot be garnisheed, nor can an executor or a guardian, until 


PROVISIONAL REMEDY OF GARNISHMENT 


345 


his accounts have been adjusted in the probate court and a bal¬ 
ance found in his hands. A sheriff, or other officer of the law, 
cannot be garnisheed as to money in his hands in his official 
capacity. A receiver, however, is amenable to garnishee proc¬ 
ess in the absence of statutory provision, and when the process 
does not tend to disturb his rights under the general orders of 
the appointing court. 

Property Subject to Garnishment 

As a general rule, to render a third party liable as garnishee 
it is necessary that it appear in the garnishment proceedings 
that the garnishee has in his possession property or credits 
belonging to the debtor, or that the garnishee is indebted to the 
debtor, because the creditor stands in the same relative position 
to the property or funds garnished as the debtor, and conse¬ 
quently can enforce only such derivative rights as were 
possessed by the debtor. In other words, the garnishee cannot 
be put in a worse position by virtue of the institution of 
garnishment proceedings. 

A test to determine whether or not a third party is liable 
as garnishee is whether the principal debtor has a right of 
action against the garnishee. However, there is an exception 
to the rule that the garnishing creditor can avail himself only 
of the legal rights of his debtor against the garnishee, and that 
is where the garnishee has in his possession property of the 
debtor which he has received under a fraudulent transfer, for 
though such transfer is valid against the debtor, the creditor 
may assert its invalidity and in many instances reach it by 
garnishment. 

The right to reach deposits in bank by garnishment pro¬ 
ceedings is generally recognized. As soon as the bank becomes 
liable to the depositor, the fund in question becomes subject to 
garnishment, which is sometimes accomplished by first exam¬ 
ining the bank under a third party order and then obtaining an 
order directing the bank to pay the funds over to a receiver. 


346 


RIGHTS AND REMEDIES OF CREDITORS 


In the case of property placed in a safety deposit box, garnish¬ 
ment against the bank which is the lessor of the box is a proper 
remedy, by the weight of authority, though there is a conflict 
of authority on the point. In such cases the court may cause 
the box to be opened to determine the garnishee’s liability. 
This is true under a statute requiring a garnishee to answer 
for any personal property of the defendant under his control. 
Where the box in the vault can be opened only by two keys— 
one a master’s key in the possesion of the bank, and the other 
a private key in the possession of the box-renter, it has been 
held that the garnishee in such a case has control of the contents 
of the box. 

Pledged or Mortgaged Property. The pledgee or 
mortgagee of personalty cannot be held as garnishee of the 
pledgor or mortgagor while the property is the subject of the 
pledge or mortgage. Collateral securities placed in the hands 
of a creditor are not garnishable. But, in some states, e.g., 
New York, you can attach the pledgor’s interest by obtaining 
an order directing the pledgee to account for the proceeds of 
sale and to turn over to the creditor any surplus remaining. 

Real Estate. It is generally recognized that an interest 
in real estate cannot be reached by process of garnishment. 

Other Cases 

A trespasser in possession of another’s goods cannot be 
charged as his garnishee. A common carrier is not subject to 
garnishment for goods in actual transit at the time of service 
of process. Property outside the state cannot be garnisheed. 
A creditor of a fraudulent mortgagor, however, may reach 
the property included in such mortgage by garnishing the 
mortgagee. 

Property Must be in Possession of the Garnishee 

The property must be in the actual possession of the 
garnishee, or so within his power and control that he can turn 


PROVISIONAL REMEDY OF GARNISHMENT 


347 


it over to the court. A mere constructive possession will not 
suffice. 1 rust funds in his hands, or money held by him in a 
fiduciary capacity, cannot be reached. Likewise, property held 
by an assignee under a valid assignment for the benefit of 
creditors is not subject to attachment or garnishment for the 
assignor’s debts. A trustee under a deed of trust for the 
benefit of creditors is not subject to garnishment where it 
appears that the purposes for which the trust was created have 
not been accomplished and that after the execution of the trust 
there will be no surplus in the hands of the trustee. Nor can 
funds in the hands of a trustee in bankruptcy be garnisheed in 
a suit against a creditor of the estate. 

Only Rights of Defendant against Garnishee Acquired 

An attaching creditor cannot acquire through his attach¬ 
ment any greater right to the property or credits attached than 
the defendant had when the attachment was made, unless he 
can show some fraud or collusion whereby his rights were 
impaired. In such cases, the creditor may impeach the trans¬ 
feree’s title by showing the transfer was fraudulent. 

The creditor’s rights are, therefore, subject to any pre¬ 
existing contract or indebtedness between the debtor and the 
garnishee, and if the garnishee has a lien on the property, the 
creditor can only take the property which is subject to that 
lien. 

Jurisdiction in Garnishment of Debt 

As to just what constitutes the necessary legal jurisdiction 
to give validity to proceedings in the garnishment of a debt 
is a question difficult of solution in the actual state of authori¬ 
ties. It may be stated generally that the trend of decisions is 
toward establishing the principle that a debt has, for the pur¬ 
poses of attachment, a situs, and that this situs must be within 
the jurisdiction of the court where relief is sought. Further¬ 
more, the prevalent view would seem to be that the situs of a 


34 ^ 


RIGHTS AND REMEDIES OF CREDITORS 


debt for the purposes of garnishment is at the domicile of the 
debtor, the garnishee. 1 

It has also been held, however, that the situs may be at the 
domicile of the creditor, and, of course, to attach the debt there, 
service must also be had on the debtor, who accordingly must 
be capable of being served at the creditor’s residence. 2 If the 
debt is a judgment debt, it can only be seized at the place where 
the judgment was rendered, provided, as before, service can be 
had on the garnishee. 

Still another view recognizes that the debt has a situs, and 
insists that wherever the garnishee could be sued by the creditor 
the debt may be attached. 3 This far-reaching view, which 
apparently conceives of the debtor as carrying the obligation 
with him wherever he goes, is questionable in the light of the 
other authorities submitted. 

Ordinarily speaking, no court can be said to control the 
debt, which consists in compelling its payment and release, 
except the court which has jurisdiction over both parties. 
Consequently, it would seem that application for an order, 
directing the issuance of garnishee execution should, as a gen¬ 
eral rule, be made in the judicial district in which the debtor 
resides. 

Garnishee Must be a Third Person 

By this is meant that the garnishee must not stand in such 
a relation to the defendant that his garnishment will be in 
effect the garnishment of the defendant himself. Therefore, 
an agent cannot be garnisheed as to funds in his hands for his 

principal; nor can the cashier of a bank in which a debtor’s 

funds are deposited. In an action against one of a firm, a 

debtor to the firm cannot be made a garnishee. One having 

possession of mortgaged chattels as the mortgagee’s agent 
cannot be charged as garnishee of the mortgagor. 


1 174 U. S. 710. 

2 23 So. Rep. 825. 

8 127 Mo. 242. 



PROVISIONAL REMEDY OF GARNISHMENT 


349 


Garnishment of Judgment Debts 

There is a conflict of authority as to the right to make a 
judgment debtor a garnishee. It has been held that a judgment 
debt is subject to garnishee process from the court in which 
the judgment was recovered but not from any other court. 4 
It has also been held that a judgment debtor cannot be garni¬ 
sheed in any event, because he would be unfairly burdened 
and exposed to double liability. The force of this argument, 
however, is very slight where the garnishee process is in the 
court which rendered the judgment, as the court can then easily 
protect the debtor, at least before execution has issued. The 
weight of American authority, however, seems to be in favor 
of a more liberal view, and a few courts have gone so far as 
to make judgment debts subject to garnishment in any court. 

Effect of a Judgment against a Garnishee 

Assuming a judgment has been taken against the debtor for 
$500 and also against a garnishee for, say, $300, is the debtor 
still liable to the creditor for the full $500 judgment, or for 
only the difference between the $500 and the $300 which is 
owing to the creditor from the garnishee? 

As between the creditor and the principal debtor in garnish¬ 
ment proceedings, the effect of a judgment in favor of the 
creditor is to place the latter in possession of all the rights of 
the debtor against the garnishee involved in such proceedings, 
and it is well settled that the satisfaction of a valid judgment 
against a garnishee operates to merge or satisfy the liability of 
the principal debtor either pro tanto or in full, as the case 
may be. 

Some cases go still further and hold that if the defendant 
pays into court the difference between the amount of the 
judgment against the garnishee and that against himself, he 
is entitled to have the judgment against himself discharged 


* 39 At. Rep. 436; 52 Pac. 220. 



350 


RIGHTS AND REMEDIES OF CREDITORS 


as satisfied. 5 The substance of this decision is that the 
judgment against a garnishee is equivalent to a levy on the 
defendant’s property in the hands of the garnishee. 

Acceptance of the principle laid down by the court in this 
case gives rise to speculation as to whether it was ever intended 
that garnishment statutes should force the party who takes 
advantage of them to accept the liability of some third party as 
a substitute for that of his debtor. Exceptions to this view 
may be found. One court has held that the judgment against 
a garnishee is in the nature of collateral security for the satis¬ 
faction of the principal obligation. In commenting upon the 
legal significance of such a judgment, the court stated, in its 
opinion, that “it is subordinate and incidental to the judgment 
against the defendant, and it is difficult to find any principle 
by which it could become a ground for discharging his 
liability.” A valid judgment in a garnishment suit, like any 
other judgment, is entitled to full faith and credit in any other 
state. 

Interrogatories 

Provision is sometimes made by statute whereby the plain¬ 
tiff in garnishment, or third party, proceedings is required to 
file interrogatories which he desires to have answered by the 
garnishee as to his indebtedness to the defendant and which 
the garnishee is required to answer. In some jurisdictions he 
may be examined orally. If a garnishee fails to appear and 
answer, the plaintiff may proceed against him in an action in 
his own name. When sued the garnishee may avail himself 
of any defense which he might urge in an action brought 
against him by the defendant debtor. 

When the answer of the garnishee on his examination 
under oath in garnishment proceedings is satisfactory to the 
plaintiff, the judgment of the court may be taken thereon; but 


B 80 N. W. Rep. 345. 



PROVISIONAL REMEDY OF GARNISHMENT 


351 


when his answer is not satisfactory to the plaintiff, an issue 
may be made up and tried by a jury as in other actions. 

In some jurisdictions a judgment is not rendered against 
the garnishee. All that the creditor can do is to obtain an order 
against the garnishee to appear and answer, and upon such 
appearance, if the debt is admitted, an order may be made for 
its payment into court; and if the debt is denied, an order may 
be entered authorizing the judgment creditor to institute an 
action to recover the alleged debt. 

The fact that the principal debtor has made a valid assign¬ 
ment of his claim against the garnishee so that the garnishee is 
liable to the assignee of the debtor, defeats garnishment pro¬ 
ceedings, and the garnishee may in his own defense set up the 
rights of the assignee to whom he is liable. 

Liability for Costs 

As a rule the court may allow the garnishee his costs in 
the garnishment proceedings and in some jurisdictions the court 
may allow him compensation to meet his expenses, including 
a reasonable attorney’s fee. But if the garnishee denies all 
liability and the judgment is subsequently entered against him, 
he may be held liable for the costs. 


CHAPTER XXVIII 


THE PROVISIONAL REMEDY OF REPLEVIN 
Nature 

It is too familiar to every credit man to require being 
formally stated and explained that a breach of contract gives 
rise to a right of action for damages, but in case of insolvency 
or fraud a decided advantage would acrue to a seller of mer¬ 
chandise if he were able to reclaim and retake his property, or, 
as it is technically termed, to exercise a “right of recaption.” In 
chandise if he were able to reclaim and retake his property, or, 
loss suffered through reliance on a false statement, whether 
submitted direct to the seller, or through the intermediary of 
an agent, as the mercantile agencies, such a remedy is often 
impracticable, because if the financial statement was false and 
the buyer is unable in fact to pay for the goods, what good 
does it avail a creditor to have a judgment which he cannot 
collect? 

Object of Replevin 

Hence, the justice in giving him the greater right, that of 
recaption or replevin, under such circumstances is obvious, and 
in certain cases the law does afford just such a remedy. For 
instance, as pointed out in Chapter XXV, a seller having 
shipped goods under a straight bill of lading to a consignee 
who becomes insolvent after the shipment is made, is given the 
legal right of stoppage in transitu, or right to stop the goods in 
transit and retake them from the carrier; and it would seem 
that the same principles of justice which underlie this right 
would likewise apply in the analogous case of a shipper con¬ 
signing goods to a fraudulent buyer, the point in common being 

352 


PROVISIONAL REMEDY OF REPLEVIN 


353 


that the prospects of collecting the sale price are very remote in 
both instances. In fact, the law has so regarded it and provided 
the same remedy for it. So the general principle of law on the 
subject may be summed up by saying that even though the 
seller of goods voluntarily delivers them to the buyer (directly 
or through an agent), the latter is guilty of a wrongful taking 
if he obtains them by such fraud as justifies the seller in 
rescinding or avoiding the sale, and upon its avoidance the 
owner may insist that no title or right of possession ever passed 
to the defrauder, and retake the goods, provided he executes 
a bond, or undertaking, as security to the purchaser against 
any injustice he may suffer as the result of such action. 


Legal Procedure 

In actual practice, however, the procedure consists in the 
owner of the goods applying in the proper court for a writ of 
replevin (Form 19), and specifying the property he claims and 
the grounds on which his claim is based. When granted, this 
writ authorizes and directs the sheriff, or other officer of the 
court, to seize the property and bring it into court, whereupon 


Writ of Replevin, with Summons 


Damages claimed, $ 


The State of Ohio. County, ss. 

To Any Constable of.Township. 

You are hereby commanded to summon . 

to appear before me, the undersigned, a Justice of the Peace in and for the 

said County, at my office therein, on the .day of .. 

19. . .., at.o’clock .. M., to answer the action of .. 

.for wrongfully detaining the following described goods and 

chattels of the said .to wit: 


You are further commanded immediately to seize and take into your cus¬ 
tody, wherever they may be found in said County, the said goods and chattels 
above mentioned, and keep the same in your possession till further order of 
this court. 

You will make due return of this writ on the.day of., 

A. D. !9- _ 

Given under my hand, this.day of.. .., A. D. 19.... 

.Justice of the Peace 

Form 19. Writ of Replevin 





















354 


RIGHTS AND REMEDIES OF CREDITORS 


the possessor (the one from whom the property has just been 
taken) is given the privilege of what is known as “bonding 
back” the property, by giving security for its return in event it 
is decided that he is not rightfully in possession of it. In this 
way the rightful owner is protected against any loss, misuse, or 
conversion of the property, pending a decision as to the merits 
of his claim. 

In other words, a creditor’s right of replevin is the proper 
remedy to regain possession of goods which have been wrong¬ 
fully taken or acquired from the possession of the creditor, 
and which he claims as the rightful owner. Where a portion 
of the property cannot be replevied because the defendants 
have destroyed, concealed, or sold such portion, the plaintiff 
may replevy such portion of the property as can be found and 
maintain a separate action to recover the value of the rest. 

Originally it was necessary to prove not only the wrongful 
possession of the goods, but that there had been a wrongful 
taking or seizure, or that the defendant had come into posses¬ 
sion of them unlawfully. But in most all the states this rule 
has been modified, and replevin, when allowed at all, lies for a 
wrongful detention or withholding of the goods by one who, in 
the first instance, came into possession of them lawfully. Thus 
the action will lie for goods wrongfully detained by a fraud¬ 
ulent purchaser, or against any other person in whose posses¬ 
sion personal property which has been unlawfully taken is 
found. 

A judgment in replevin, where there is no assessment of 
damages, merely determines the right of possession. 

Right to Possession Necessary 

To maintain such an action the plaintiff must have a present 
right to immediate possession of the property. In other words, 
it is not sufficient for the plaintiff in replevin to have a clear 
legal title to the property in controversy; he must also be 
entitled to the immediate possession; e.g., in an action by a 


PROVISIONAL REMEDY OF REPLEVIN 


355 


mortgagee to obtain possession of mortgaged personalty, an 
allegation that the goods were mortgaged to him was held 
insufficient as not showing who was entitled to possession. 

Assuming a trade acceptance to have been tendered in pay¬ 
ment for the goods, it has been held that if the seller retains 
possession of the trade acceptance, or if he is able to render 
return of the instrument, he does not lose his right of replevin. 
Tender of the instrument is necessary, however, to maintain 
this right. 

What Property May and May Not be Replevied 

The owner of property wrongfully taken may pursue it so 
long as it may be identified, regardless of whatever altera¬ 
tion in form it may assume, unless it has been annexed to, or 
become a part of, some other commodity. Furthermore, a 
purchaser from the defendant of property which is the subject 
matter in an action for replevin, who purchases with notice 
of the litigation pending, buys at his peril, and if judgment is 
afterwards rendered against the defendant it becomes the duty 
of the sheriff to take the property from such purchaser not¬ 
withstanding the fact he may have paid full value for it. 

Suppose goods are conditionally sold and then removed by 
the purchaser from the place where they were to remain until 
paid for. The seller has a right to replevy the goods. 

Replevin will lie for choses in action, such as notes, checks, 
bonds, etc., as well as for goods, wares, and merchandise. 

Demand—When Necessary 

Where the goods come into the defendant’s possession with¬ 
out any wrongdoing on his part, a demand for the return of 
them is essential, and the action will not lie against a purchaser 
in good faith from a wrongful taker until after such a demand 
has been made. But a demand is not necessary where the 
taking was wrongful; for example, where the defendant pur¬ 
chased the goods with knowledge that the party who sold them 


RIGHTS AND REMEDIES OF CREDITORS 


356 

had obtained them by fraud. Where goods are delivered by 
mistake to one who has no right to the possession of them, and 
he, instead of endeavoring to correct the mistake, retains pos¬ 
session and claims a lien upon them, the owner may regard him 
as a wrongdoer and maintain an action against him without 
demand. 

A consignee of goods sent C. O. D. cannot maintain 
replevin against the carrier before payment and delivery. A 
tender of the purchase money and demand for the goods are 
essential to replevying the goods under circumstances such as 
these. 

Defenses 

An action of replevin is barred by any proof that the plain¬ 
tiff, when he began the suit, had no right to the possession. 
For example, an action to recover possession of personal 
property may be defeated by showing that the defendant has 
been required to deliver the property to a third person entitled 
to its possession. However, the mere fact that title to the 
property is in a third party, or that some third party has a lien 
on the goods, is no good defense; the plaintiff in such instances 
simply takes subject thereto. 

Damages 

The primary purpose of replevin is to recover the prop¬ 
erty in specie and not its value. The defendant, however, 
has his election to deliver the property specified in the writ 
when the sheriff calls for it, or to retain it by giving a security 
bond. If the property be surrendered, the defendant is still 
answerable in damages for the taking and detention of it up 
to the time of delivery. If retained, he is liable, in addition, 
for the full value of the goods, and in no event can the prop¬ 
erty itself be recovered from the defendant; nor can he tender 
it afterwards in discharge of the action. 

The measure of damages where the property cannot be 


PROVISIONAL REMEDY OF REPLEVIN 


357 

returned is the value of the property at the time it was replevied 
plus damages for the injury sustained. 

The Bond 

The plaintiff in an action of replevin is required, as a 
prerequisite to the service of the writ, to give a bond of 
indemnity with sureties to return the goods if a return be 
ordered, or to pay all costs and damages resulting from the 
wrongful suing out of the writ. The amount of the bond is 
always at least double the value of the property or goods. 


CHAPTER XXIX 


THE BULK SALES LAW 

Sale of Goods in Bulk 

Another statutory aid that has been devised to protect 
creditors against fraud on the part of their debtors is com¬ 
monly known as the “Bulk Sales Law.” Such statutes have 
been enacted in all of the states. They are practically similar 
and have been given similar force and effect by the interpreta¬ 
tions placed upon them by the courts. 

Two concrete examples will serve to illustrate the general 
situation with which these statutes have to deal: 

1. Suppose A is a wholesale grocer carrying a stock of goods 
valued on his property statement at $2,000, and on the strength 
of which you as a credit man have extended him credit and 
filled his orders up to $500. The next information you receive 
regarding A is that he sold out his entire stock of goods to B, 
a bona fide purchaser for value, last week for $1,500, purchased 
an automobile, and in learning to run it met with an accident 
in which the car was totally wrecked. Ordinarily, in the 
absence of some special statute, as a creditor of A you would have 
no claim against B personally, or against the goods he purchased 
from A. Your only claim was against A personally, who now 
has no other assets over and above his $500 legal exemption. 

The opportunity presented by such a situation for the 
perpetration of fraud is readily apparent, and before the enact¬ 
ment of the Bulk Sales Law it was not an uncommon prac¬ 
tice for dishonest debtors, in an attempt to defraud their 
creditors, to sell their entire stock in bulk at a quick sale and at 
a low valuation, and then dissipate or conceal the proceeds. 

2. Suppose that instead of selling the goods in bulk to some 
third person, the business of the individual merchant or partner- 

358 


THE BULK SALES LAW 


359 


ship is incorporated and the entire property of the merchant 
transferred to the corporation in exchange for corporate stock. 

In so far as the rights of creditors in the stock of the mer¬ 
chant are concerned, they are cut off just as completely and 
effectively as in the first case, where the goods were sold out¬ 
right. 

Purpose of Law 

It is obvious that there should be some means to prevent 
such a sale or transfer being consummated without giving 
the creditors an opportunity for self-protection against such 
a contingency, for in granting mercantile credit it is generally 
assumed as a matter of fact that the customary methods of 
trade will be followed by the merchant and that the debt thus 
incurred will be paid from the proceeds derived from the sale 
of the goods in the ordinary course of business. It there¬ 
fore constitutes a breach of good faith when the merchant 
totally disregards that which is justifiably expected of him 
and disposes of his goods in bulk in such manner as to pre¬ 
clude any claim whatsoever by the creditor against the stock 
after it is sold. For if the seller had anticipated any such 
deviation from the usual course of business and that the goods 
would be sold in bulk to a single purchaser, the order doubt¬ 
less would not have been filled, because the fact that the mer¬ 
chant has his present reputation to protect as a safeguard of 
his future success is one which enters largely into the ques¬ 
tion of selling goods on credit. 

It was this general situation which gave rise to the enact¬ 
ment of what is known as a “Bulk Sales Law” in every state 
in the Union, 1 and while the laws of the different states vary 
in their formal requirements, the substance of all of them is 
practically the same. Consideration of the Bulk Sales Law of 


1 The purpose of these statutes has been stated to be as follows: 

“The object of the Act was to suppress the wide-spread evil and practice of merchants 
who are heavily in debt from making secret sales of their merchandise in bulk for the purpose 
of defrauding their creditors.” (Wright v. Hart, 182 N. Y. 330.) 



RIGHTS AND REMEDIES OF CREDITORS 


360 

New York will, therefore, serve our purpose quite as well 
that of any other state. It provides that: 

The sale, transfer or assignment, in bulk, of any part of the 
whole of a stock of merchandise, or merchandise and fixtures 
pertaining to the conducting of said business, otherwise than in 
the ordinary course of trade and in the regular and usual prose¬ 
cution of the business of the sellers, transferrer or assignor, shall 
be void as against the creditors of the seller, transferrer, assignor, 
unless the purchaser, transferee or assignee demands and receives 
from the seller, transferrer or assignor a written list of names 
and addresses of the creditors of the seller, transferrer or assignor, 
with the amount of the indebtedness due or owing to each and 
certified by the seller, transferrer and assignor, under oath, to 
be a full, accurate and complete list of his creditors, and of his 
indebtedness; and unless the purchaser, transferee or assignee, 
shall at least five (5) days before taking possession of such mer¬ 
chandise, or merchandise and fixtures, or paying therefor, notify 
personally, or by registered mail, every creditor whose name 
and address appears in said list, or of which he has knowledge, 
of the proposed sale and of the price, terms and conditions 
thereof. 

Sellers, transferrers and assignors, purchasers, transferees 
and assignees, under this act shall include corporations, associa¬ 
tions, co-partnerships and individuals, but nothing contained in 
this act shall apply to sales by executors, administrators, guar¬ 
dians, receivers, trustees in bankruptcy or by any public officer 
under judicial process. 

Any purchaser, transferee or assignee, who shall not conform 
to the provisions of this act shall at any time within ninety days 
after such sale upon application of any of the creditors of the 
seller, transferrer or assignor, become a trustee and be held 
accountable to such creditors, for all the goods, wares, mer¬ 
chandise and fixtures that have come into his possession by 
virtue of such sale, transfer or assignment, provided, however, 
that any purchaser, transferee or assignee, who shall conform to 
the provisions of this act shall not in any way be held account¬ 
able to any creditor of the seller, transferrer or assignor, or to the 
seller, transferrer or assignor for any of the goods, wares, 
merchandise or fixtures that have come into the possession of 
said purchaser, transferee or assignee by virtue of such sale, 
transfer or assignment. 


THE BULK SALES LAW 


361 

Such legislation applies only to business men who are 
engaged in the retail trade. 

Question of Constitutionality 

In several instances (Ohio, Utah, New York, and Illinois) 
such a law when passed by the state legislature had at first 
been declared unconstitutional by the state courts on the 
grounds that it constituted legislation in restraint of trade and 
unlawfully restricted the right of contract and the disposition 
of one’s property. Later enactments in these states have been 
upheld by the courts. 

In declaring the first Ohio law unconstitutional, 2 the court 
in its opinion stated: 

The United States Constitution guarantees the right of the 
individual to acquire, possess and enjoy property with all of its 
incidents and attributes, and it is the duty of the judicial depart¬ 
ment to shield that right from legislative encroachment. 

For every restriction upon the enjoyment and use of property 
there must be substantial reasons of a public character. If a 
restriction is placed upon the alienation of property, it must be 
for the entire body of the people, or at least, of all who are 
within the reason of its restriction. A distinction sometimes 
thought important between property in land and in chattels 
upon the ground that the former is derived from the state, will 
at least justify the conclusion that legislative control over 
chattels is not greater than over lands. The express limitations 
which the Constitution imposes upon the legislature apply to 
the exercise of powers which are truly negative in character, 
and since none but legislative power is committed to it, the 
exercise of that power is also confined within all the limitations 
which are suggested by its nature. 

Applying the familiar and unquestioned rule that the validity 
of an Act is to be determined by its practical operation and not 
by its title or declared purpose, this Act under guise of preventing 
fraud in such sales, prohibits them altogether, and this places 
on the enjoyment of property an important restriction which no 
public interest requires and which the Constitution therefore 


2 Miller v, Crawford, 70 Ohio 207. 




362 


RIGHTS AND REMEDIES OF CREDITORS 


forbids. One who challenges the soundness of this conclusion 
should be prepared to maintain the validity of an Act expressly 
forbidding sales of stocks of merchandise in bulk. By the Act 
the legislature has attempted to discriminate unwarrantably 
among debtors and creditors. It does, in liens, apply to sales 
in bulk by wholesale as well as by retail dealers in merchandise. 

But conceding for present purposes, that when reasons for legis¬ 
lative discrimination exist, then sufficiency is to be determined 
finally by the legislature; no reason is suggested by counsel, nor 
does any occur to us, for a legal discrimination in the relation 
of debtor and creditor between those who come into that rela¬ 
tion with respect to the purchase and sale of merchandise, and 
those between whom it exists with respect to chattels in general. 
Although the Act applies to all creditors of the seller, it applies 
to those only who are creditors of the owner of a stock of mer¬ 
chandise, and thus an unreasonable burden is imposed upon a 
limited class of debtors for the supposed benefit of a limited class 
who are creditors. 

In commenting on the constitutionality of the later New 
York statute, Justice Johnson of the Supreme Court said: 

It is a matter of common knowledge that the business of 
retail merchandising is conducted largely upon credit. This 
system has come about as a natural outgrowth of the vast increase 
in the facilities of transportation and communication in modem 
times. It was not surprising that a system, so built up and 
conducted, should be attended with abuses, for it furnished an 
opportunity for the commission of frauds upon creditors not 
usual in other forms of business. There was a temptation to 
sell stocks in bulk without providing for the payment of creditors 
from whom they were bought. It was natural and inevitable 
that such an important subject should be called to the attention 
of the legislatures and courts. 

We think it clear that there are substantial reasons for the 
classification made by this statute. It applies equally to all 
merchants having a stock of merchandise for sale in the usual 
course of trade who have creditors. It operates upon such class 
when there is contemplated a bulk sale of the stock otherwise 
than in the ordinary course of trade. It relates to all purchasers. 

It affects all within the class of creditors of such merchants. The 
necessary results of its operation would be in the interest of honest 


THE BULK SALES LAW 


363 


merchants and of the public welfare, for these are concerned in 

the prevention of frauds and in the protection of public morals. 

Creditor’s Remedy for Violation 

Perhaps the most important uniform requirement of these 
statutes is that the buyer must notify the creditors of the 
seller that the sale is to be made, and, assuming that proper 
notice has been given by the purchaser, the purpose of the 
law is to afford the creditors a reasonable time in which to 
attach the merchandise, stock, or fixtures, or resort to any 
other form of legal process competent to recover the assets 
for the payment of their claims. 

On the other hand, if the statute has not been complied 
with, and no such notice is given by the purchaser, the 
creditor’s remedy is by way of application to the court for the 
appointment of a receiver to take over the property which 
has been transferred; or by setting forth the facts and re¬ 
questing that the purchaser be declared a trustee of the goods 
for the benefit of the creditors of the seller. If the applica¬ 
tion is granted an appraisement of the property is made, 
which is then sold, the proceeds being applied in payment of 
the creditors of the original seller. Such a petition to the 
court must, as a rule, be made within 90 days subsequent to 
the transfer of the goods or property. 

Protection Afforded 

The chief obstacle encountered in the prosecution of fraud 
in any form is the difficulty in substantiating the necessary 
allegation of fraudulent intent, and the practical value of the 
Bulk Sales Law to a mercantile creditor in seeking to set aside 
sales of goods as fraudulent lies in the fact that it places the 
burden of proof upon the defendant. The creditor is merely 
obliged to show that the sale took place without conforming 
to the requirements of the Bulk Sales Law, in order to raise 
a presumption that the sale was fraudulent and thus shift 


364 


RIGHTS AND REMEDIES OF CREDITORS 


the burden of proof to the defendant, who is then obliged to 
prove that the sale was bona fide. 

Practical Application 

The enforcement of the Bulk Sales Law varies in some 
states in accordance with the statutes pertaining to attach¬ 
ments, garnishee process, and other provisional remedies of 
an unpaid creditor. A typical case, however, would be for 
the commencement of an action by the creditor against the 
debtor and the purchaser of goods in bulk, in which case an 
attachment or garnishee process would be issued, setting up 
fraud in that the terms of the Bulk Sales Law were not com¬ 
plied with. Armed with this process, the sheriff, or other ap¬ 
propriate officer, seizes the goods thus sold in bulk from the 
possession of the purchaser and holds them to await the out¬ 
come of the trial of the action. In that action the creditor 
merely shows that the debtor sold his stock without complying 
with the act, and this creates a prima facie case in support of 
the creditor’s contention that the sale was fraudulent. If the 
debtor or the purchaser of the goods in bulk is unable to 
show that he gave full value for the property, and had no 
reason to suppose that the property was being disposed of for 
the purpose of defrauding creditors, the plaintiff would win 
his action ,and the sheriff would turn over the goods or the 
proceeds from their sale at auction to him under the execution 
issued upon the judgment. 

If, on the other hand, the purchaser of the goods in bulk 
succeeded in showing that the purchase was made by him for 
approximately fair value, without fraud of any kind, the 
attachment would be vacated and the creditor would lose his 
case, except in those states where sales in bulk are declared 
absolutely void for non-conformity with the statute. 

In the latter case, assuming that the proper notice has been 
given by the purchaser under the Bulk Sales Law and the 
money paid over, but the possession of the merchandise not 


THE BULK SALES LAW 


365 

taken at the end of the fifth day, the creditors may attach the 
merchandise, stock, or fixtures, or use any other legal process 
competent to preserve the assets for the payment of their 
claims. If possession of the stock has been taken in less than 
five days, the notice duly given by the purchaser under the 
Bulk Sales Law, and the money was held until the end of the 
five days, the creditor may then subject 3 the money in the 
hands of the purchaser to the payment of his claim. 

In states where the sale is by statute made absolutely void 
for non-conformity, the creditor is merely obliged to prove 
that the sale took place without conforming to the require¬ 
ments of the Bulk Sales Law to be set aside by a decree of 1 
the court, whereupon the property becomes subject to levy in 
the hands of the purchaser under an execution against the 
seller. 

When Statute Is Applicable 

To come within the statutory provisions of the Bulk 
Sales Law, the sale must be “in bulk,” of “the whole or a 
major part,” or “more than half” of a stock of goods or 
merchandise, and must be made otherwise than in the ordinary 
course of trade and in the regular and usual prosecution of 
the seller’s business. The question as to whether a sale was 
made in the ordinary course of business, or whether an unusual 
method of disposing of the stock of goods was employed is 
essentially one of fact, depending upon the nature of the seller’s 
business. 

The inadvertent omission of the name of one or a few 
creditors from a list of creditors presented by the seller to 
the buyer in accordance with the statutory requirements, or 
the failure of the purchaser acting in good faith to notify a 
single creditor or a few creditors of his intention to purchase 
the goods, has been held not to give ground for holding the 
sale fraudulent and void. 


• See circular of National Association of Credit Men. 



366 


RIGHTS AND REMEDIES OF CREDITORS 


Store fixtures do not constitute part of a stock of goods 
within the meaning of the statutes, but are specifically in¬ 
cluded in most states. 

Methods of Evasion 

Evasion of the law has been attempted by having the seller 
execute a chattel mortgage, fail to record it, and then subse¬ 
quently release his equity of redemption to the purchaser. The 
effect of the release given under such circumstances is to 
transfer an absolute legal title to the previously mortgaged 
goods to the purchaser, and it has therefore been held to con¬ 
stitute a “sale” within the meaning of the Bulk Sales Law. 

Another method of evading the law, and one which has 
proved successful, provides for a double transfer of the goods, 
e.g., a sale is first made by A to B, and then a resale made 
by B to C, the transfer in both instances being without notice 
to the creditors of A, who in such a case have been denied 
recourse to the goods in the hands of C, the court holding 
that the law requires notice to be given only by the immediate 
vendee of the transferrer. 4 

Tabular Analysis of the State Statutes 

The Bulk Sales Laws of the different states may be classi¬ 
fied into three groups, in accordance with the effect a non- 
compliance with the statutory requirements has upon the 
validity of the sale. The first group consists of some 16 
states wherein the failure to comply with the statute renders 
the sale absolutely void, and the goods are subject to attach¬ 
ment in the hands of the transferee under a writ of execution 
against the property of the seller. These states are the fol¬ 
lowing : 


Arizona 

Arkansas 

Colorado 


Connecticut 

Indiana 

Iowa 


4 See Credit Men’s Manual of Commercial Laws, p. 108. 



THE BULK SALES LAW 


367 


Kansas 

Maine 

Maryland 

Michigan 

Nebraska 


New York 
North Dakota 
Ohio 
Texas 
Virginia 


In the following 20 states the statute provides that the 
effect of non-compliance with the statutory requirements is 
to render such sale or transfer both void and fraudulent: 


California 

District of Columbia 

Idaho 

Illinois 

Kentucky 

Massachusetts 

Mississippi 

Missouri 

Montana 

Nevada 


New Hampshire 

New Mexico 

Oregon 

Pennsylvania 

Rhode Island 

Utah 

Vermont 

Washington 

West Virginia 

Wisconsin 


In the following 12 states the effect of non-compliance is 
to create a presumption that the transfer was fraudulent and 
void; but in the absence of proof of fraud, a sale in disregard 
of the statute will not be set aside: 


Alabama 

New Jersey 

Delaware 

North Carolina 

Florida 

Oklahoma 

Georgia 

South Carolina 

Louisiana 

Tennessee 

Minnesota 

Wyoming 


CHAPTER XXX 


COMMERCIAL FRAUD 


Get a reputation for giving full measure, for being generous 
in times of pressure and panic, and for charity towards mis¬ 
fortune, but by all you hold sacred or holy, get a reputation .for^ 
getting the last ounce of flesh from the man who tries to “do” 

you in any manner, shape, or form. 

Reluctance to Prosecute for Fraud 

Lawsuits of any nature are distasteful to business men, 
who as a rule take advantage of any proper way to avoid 
them. They extend over too long a period, cost too much 
money, their results are too uncertain, and in a way they reflect 
upon the manner in which a man’s business is conducted. 
For this reason business men as a rule are too prone to enter 
into compromise settlements as the path of least resistance out 
of an otherwise difficult situation; but it is unquestionably 
a mistake to enter into such a settlement when any suspicion 
of fraud is present, because so long as your claim remains un¬ 
paid, you hold a club over the debtor’s head, which is often 
valuable in placing a dishonest debtor behind the bars. 

There is also another very good reason why the number of 
prosecutions for commercial fraud is limited—simply because 
there is a large class of technical frauds for which the law 
affords no legal remedy. In fact it is surprising, and at the 
same time discouraging from a credit man’s viewpoint, to see 
the extent to which a certain class of unscrupulous tradesmen 
with which the business world is infected, can go in the way 
of sharp practice and still remain “within the law.” More¬ 
over, in many instances where the law does afford a remedy 
the prosecution is so fettered by legal restrictions in the nature 

368 


COMMERCIAL FRAUD 


369 

of technical rules of evidence as to render conviction doubly 
difficult, inasmuch as a preponderance of evidence in civil suits 
suffices for the prosecution to prove its case, whereas in crimi¬ 
nal cases it is necessary to establish one’s case beyond any 
reasonable doubt to obtain a conviction. 

What Constitutes Fraud 

Fraud, as a generic term, is legally defined as consisting 
of “(0 any artifice or deception practiced to cheat, deceive 
or circumvent another to his injury; (2) any act, omission, 
or concealment that involves a breach of duty, trust or confi¬ 
dence, and which is injurious to another, or by which an undue 
advantage is taken of another.” 

Practically, however, there are two kinds of fraud—civil 
and criminal—depending on the nature of legal redress af¬ 
forded. The former class consists of deceitful practices which 
do not reach the gravity of criminal fraud, and give rise to a 
right of action for damages, while the latter class, with which 
we are here concerned, consists of practices of a more serious 
nature for which punitive measures have been provided. 

Practical Difficulty Encountered in Criminal Prosecution 

To illustrate the difficulty encountered in criminal prosecu¬ 
tion, let us examine the elements or requirements necessary to 
establish a case under the False Statement Law: 

1. The statement “must be in writing.” Should I drop 
in your office and tell you that my business assets amount to 
$20,000, liabilities to $11,000, and working capital approxi¬ 
mately to $6,000, on the strength of which you extend me 
credit up to $500, you could not prosecute me under this 
statute (unless it so provided). 

2. The “statement” must be false, as ostensibly showing 
his actual condition “as of a certain time.” Hence the im¬ 
portance of the date on which the statement was made up. 

3. The statement “must have been known to be false by the 


370 


RIGHTS AND REMEDIES OF CREDITORS 


maker.” A person who innocently, or thoughtlessly, makes a 
misrepresentation is guilty of no crime, even though his rep¬ 
resentation may result in loss to others. He must either know 
it is untrue, or have been “criminally negligent” in not verify¬ 
ing it before it was sent out. “Bad faith” is the very essence 
of this requisite. 

4. The statement must have been made “with intent to be 
relied on” or “to defraud.” If it is made to someone merely 
with a view, or intent, to mislead him, or as a means of evasion 
of some personal inquiry as to the true condition of your busi¬ 
ness affairs, you are not guilty of any crime because the mis¬ 
representation must have been made with intent to defraud. 
In case of mistake there is practically no redress, although the 
law does provide some remedy of a civil and criminal nature 
where money or property has been obtained under false pre¬ 
tenses. 

5. The statement “must be acted on” or the “creditor must 
have relied on the misrepresentation in extending the credit.” 
For example, suppose A has made a false statement to procure 
credit; if the seller did not rely on that false statement, but 
made inquiries through other sources, and depended solely and 
entirely on the information obtained through this supplemental 
investigation, A is not liable. The false representation must 
have been relied on exclusively or in part to be taken advantage 
of in maintaining such an action. “The law was intended to 
be used as a shield, not as a sword.” 

6. “The creditor must have suffered damage or loss as a 
result of it,” for in such cases recovery is allowed as compen¬ 
sation for the injury suffered, and a penalty to prevent the 
recurrence of the wrong. The test is: Was the plaintiff 
injured; and, if so, to what extent? 

Such difficulties encountered in the prosecution of com¬ 
mercial fraud naturally lead to speculation as to whether the 
criminal laws on the subject are not too strict in their re¬ 
quirements for the good of the commercial world, which is 


COMMERCIAL FRAUD 


371 

quite a different question from asking why a larger percent¬ 
age of the perpetrators of fraud are not “sent over the hill.” 

What change or reform has taken place in criminal law 
seems to have been brought about with a view to bettering 
the social welfare of humanity and with no particular regard 
to the incidental aspect of commercial justice. For example, 
in England coercion was at one time practiced as a means of 
recovering hidden property, and imprisonment was the pre¬ 
scribed remedy for debt, but today imprisonment is almost uni¬ 
versally provided for only in aggravated cases of fraud. 

Without dwelling further on the merits of this transition, 
the effect of the change has unquestionably been to encourage 
sharp practice in business, and the laxity afforded has cer¬ 
tainly been indulged in by that class of tradesmen (fortunately 
small) who do not hesitate to reap a profit at your expense, 
and to evade, when possible, the payment of their honest debts 
in the nature of business obligations. 

This is particularly true as applying to insolvency legis¬ 
lation and the leniency afforded those who have purposely 
placed themselves in a position where they are unable to pay 
their debts. The point in this connection has been well put 
by Mr. Mill when he states: 

It is the business of law to prevent wrongdoing, and not 
simply to patch up the consequences of it when it has been 
committed. The law is bound to take care that insolvency shall 
not be a good pecuniary speculation, that men shall not have 
the privilege of hazarding other people’s property without their 
knowledge or consent, taking the profits of the enterprise if it 
is successful, and if it fails, throwing the loss upon the rightful 
owners; and that they shall not find it answers to make them¬ 
selves unable to pay their just debts, by spending the money 
of their creditors in personal indulgence. It is admitted that 
what is technically called “fraudulent bankruptcy,” the false 
pretense of inability to pay, is, when detected, properly subject 
to punishment. But does it follow that insolvency is not the 
consequence of misconduct because the inability to pay may 
be real? If a man has been a spendthrift, or a gambler, with 


372 


RIGHTS AND REMEDIES OF CREDITORS 


property on which his creditors had a prior claim, shall he pass 
scot-free because the mischief is consummated and the money 
gone? Is there any very material difference in point of morality 
between this conduct and those other kinds of dishonesty for 
example which go by the names of fraud and embezzlement? 

This should in a measure explain and account for the ap¬ 
parent apathy on the part of business men in general, and 
credit men in particular, towards the prosecution of fraud; and 
so long as it is the desire on the part of merchants to combat 
commercial fraud, but no special effort is made to do so, the 
effect is both weakening and detrimental to mercantile inter¬ 
ests. Furthermore, so long as this state of affairs continues, 
the only sources through which the prosecution of this un¬ 
scrupulous class of merchants seems likely to be accomplished 
are the national and local credit men’s associations. The 
former has appropriated quite a large fund for the purpose, 
and while it will have to be more or less cosmopolitan in carry¬ 
ing on its campaign, a striking example here and there should, 
with proper publicity, have a very salutary effect in general. 

Criminal Prosecutions No Bar to Civil Action for Damages 

There is still a very important point to be brought out in 
this connection. If the concern with which you are connected 
has been defrauded, for instance, through a forced reliance 
on misrepresentations which were knowingly made'to you by 
the party with whom you were dealing, remember that a prose¬ 
cution of the crime can be instituted in the criminal courts, and 
if there are any assets available you can also sue in the civil 
courts for the recovery of your money. At first, exception 
was taken to such procedure on the constitutional ground that 
“a man cannot be placed in jeopardy twice for the same of¬ 
fense,” but it has been held that one act may constitute two 
separate offenses in that: (i) it may violate a particular civil 
right, or obligation of a certain individual or individuals, and 
(2) affect, or violate, the rights or welfare of society in gen- 


COMMERCIAL FRAUD 


373 


eral. Our legal system affords a remedy by civil suit for dam¬ 
ages or compensation for the former, and a penalty in the 
nature of punishment as a deterrent against a repetition of 
the latter. 

Criminal Statutes 

In most states the old common law has been superseded 
by statutory law, wherein an act is not a crime unless specifi¬ 
cally made so by statute; and just as the constituents of the 
legislatures of no two states are the same, likewise the criminal 
statutes are not the same. It is not to be inferred from this 
that each state has a different code of morals from the other; 
the variation is not so radical as this. The same standards 
are common to all, and the variations constitute the exception, 
one of which happens to be the very subject we have been deal¬ 
ing with. In some states they have no such law; in others 
the statement may be made either orally or in writing, whereas 
in still others it must be in writing to come within the statute. 

It is the duty of the prosecuting attorney to prosecute 
criminals, and when you have been cheated or defrauded in 
violation of the criminal law, you ought to prosecute relentlessly 
even though your prosecution results in some temporary financial 
loss to yourself. If credit men in general will do this—will let 
the criminally inclined know that money is no object to them 
when those with whom they are dealing have violated the law— 
the practice of obtaining money or goods under false pretenses 
would soon cease, and the district attorney’s office would no 
longer be needed as a collection agency . 1 

Furthermore, when you attempt to compromise a crime 
and dismiss a case once instituted, on recovery of your money, 
you are either compounding a felony or a misdemeanor, or you 
are guilty of extortion, and this is something that is not always 
realized by those who seek to use the district attorney’s office 
as a medium for the collection of their debts, but it is the case 
nevertheless. 


From an address by W. T. Ford, former District Attorney of Los Angeles. 



CHAPTER XXXI 


CARRIER’S LIABILITY FOR GOODS IN TRANSIT 
Private Carriers 

The general term “carrier” is defined as one who under¬ 
takes to transport goods from one place to another. This 
service may be performed either by: (i) one who makes a 
regular practice or business of so doing, or (2) by one who 
undertakes to do it only in a specific instance. 

The private carrier, unlike the common carrier, does not 
hold himself out as being ready and willing to serve indis¬ 
criminately all who apply, but only in accordance with the 
special contracts which he enters into in individual cases. He 
is therefore permitted by law to “pick and choose” as to those 
with whom he will do business. He is vested with no excep¬ 
tional rights, neither does he incur any exceptional responsi¬ 
bilities over and above the duty to exercise ordinary care and 
diligence in performing his undertaking by which is meant 
such care and diligence as would ordinarily be exercised by the 
average prudent man. 

Unlike the common carrier, the private carrier of goods is 
not an insurer of the goods unless he has made himself so by 
special contract. Consequently, he is therefore liable for the 
loss of, or damage to, the goods only when it is due to his 
negligence. It has also been held that he may bargain away 
this responsibility by stipulating that he shall in no event be 
liable except in case of fraud or its equivalent. 

Common Carriers 

A common carrier of goods is one who undertakes to carry 
goods for hire for whomsoever may employ him. Whether 




374 


CARRIER’S LIABILITY FOR GOODS IN TRANSIT 


375 


one is a private or common carrier depends primarily on his 
holding out. If he purposes to serve all who apply indiscrimi¬ 
nately, he is a common carrier. It has accordingly been held 
that ferrymen, bargemen, lightermen, and owners of river 
and canal boats are common carriers of goods; also proprietors 
of land vehicles, such as express companies and railroads. 

Liabilities of Common Carrier 

The most important duties and liabilities imposed by law 
upon the common carrier of goods have been classified as: 

1. His duty to carry for all. 

2. His duty to furnish equal facilities to all. 

3. His liability for the loss of, or damage to, the goods. 

4. His liability for deviation and delay. 

Duty to Carry for All 

One of the obligations of a common carrier is to carry 
goods for any and all persons properly tendered to him for 
transportation, subject to the following limitations: 

1. The nature of his holding out. 

2. The extent of his facilities. 

3. The nature and condition of the goods. 

4. The payment of his charge in advance. 

Except as modified to this extent, a common carrier may 
be held liable by the intending shipper for any damage result¬ 
ing from such refusal. It has also been held that an injunction 
will issue to compel the common carrier to accept and trans¬ 
port goods which have been properly tendered to him. 

Nature of His Holding Out 

As the common carrier’s duty is coextensive with his hold¬ 
ing out, he is not obliged to accept goods of a kind he does not 
purport to carry nor for carriage over any other route, nor by 
any other means than those indicated by the true nature of his 
holding out. 


376 RIGHTS AND REMEDIES OF CREDITORS 

Limited Facilities 

As for the limitation afforded by his carrying facilities, 
the old rule was that the carrier’s duty is strictly limited by 
his available facilities, however insufficient they were. The 
present doctrine, however, requires the common carrier of 
goods to provide sufficient facilities to handle all the traffic that 
can reasonably be anticipated. For his failure to do so the 
carrier is correspondingly liable to the shipper for damages. 
Nor can the carrier plead limited facilities for his failure to 
accept and transport the goods tendered. The nature and 
extent of the equipment which the carrier must furnish is 
accordingly based on, and determined by, the reasonable de¬ 
mands of the traffic under the particular conditions in ques¬ 
tion. 

But the carrier is not required to provide facilities ade¬ 
quate for any demands that may be made upon him, and par¬ 
ticularly is he excused from liability for his failure to provide 
for an unusual influx of goods—an unexpected accumulation 
of freight or an extraordinary press of business. But if the 
carrier by the exercise of due diligence could have provided 
adequate facilities to handle the additional business, then he 
should not be excused for his failure to make the proper ar¬ 
rangement. 

Goods Unfit for Shipment 

The common carrier is not obliged to accept for transporta¬ 
tion goods of a dangerous nature, or goods in such condition 
as to be unfit for shipment. The high degree of responsibility 
imposed upon a common carrier is the reason for this, and the 
carrier is thus justified in refusing to receive such goods for 
transportation. Ordinarily, however, he has no right to insist 
upon being informed as to the nature of the contents of goods 
offered him for shipment. Likewise, the common carrier may 
refuse to accept for transportation goods unfit or improperly 
packed for shipment. 


CARRIER’S LIABILITY FOR GOODS IN TRANSIT 


377 


Right to Demand Payment in Advance 

It is well-settled law that the common carrier may refuse 
to carry the goods offered unless the transportation charges 
are paid in advance. In other words, since the law compels 
the common carrier to accept goods from the public indis¬ 
criminately, it also insures him against the incurrence of loss 
in conforming to the duty by demanding payment of his com¬ 
pensation in advance. If such prepayment is not made on 
demand, the carrier is then under no obligation whatsoever to 
transport the goods. The money is not required to be paid 
down, however, until the carrier receives the goods which he 
is bound to carry. The carrier should therefore first accept 
the goods, and then demand payment as a condition precedent 
to transporting them. 

Equal Facilities to All 

The common carrier must serve the public impartially and 
without any preference or discrimination among shippers as 
to the facilities which are furnished, the rates that are charged, 
or the rapidity of transport. The service must be disinterested 
with nothing in it of favoritism. This applies to the element 
of time as well as to the facilities. Shippers should be served 
in the order of their application. Consequently, by withhold¬ 
ing cars from one shipper and supplying them to a subsequent 
applicant, the duty to render impartial service is violated. 

Liability for Loss or Damage to Goods 

The law places upon a common carrier an absolute liability 
for the loss of, or damage to, goods entrusted to it for trans¬ 
portation, except that caused by: 

1. An act of God (storms, floods, hurricanes). 

2. The public enemy. 

3. The act of the shipper. 

4. Public authority. 

5. The inherent nature of the goods. 


37 $ 


RIGHTS AND REMEDIES OF CREDITORS 


Even when the loss is caused by one of these excepted 
perils, he is nevertheless liable if he fails to use reasonable 
care either to avoid such peril or to minimize the loss after 
the goods are actually exposed to it. 

By “act of the shipper” is meant those cases in which the 
damage resulting is directly due to the fault of the shipper. 
If the carrier is misled to the extent of being deceived by the 
shipper as to the real value or nature of the goods, his liability 
is limited accordingly, inasmuch as the carrier’s rate of com¬ 
pensation, and the precaution taken to safeguard the goods, are 
directly dependent upon their value and nature. 

As for loss resulting from negligence in packing or mark¬ 
ing the goods, the rule has been laid down that the carrier is 
not liable for loss or damage resulting from the fault or negli¬ 
gence of the shipper, or the improper performance of any duty 
which the latter voluntarily assumes. 

Liability for Deviation and Delay 

When the carrier without necessity or reasonable excuse 
deviates from the usual or agreed route, he becomes absolutely 
liable for the goods without any exception whatsoever, on the 
ground that such an assumed unlawful dominion over the 
goods constitutes a conversion. But in the absence of special 
contract, the common carrier is bound to use only reasonable 
care or ordinary diligence in completing the transportation 
without delay. The carrier is therefore liable for delay only 
when it is due to his negligence. If, however, the carrier 
specially agrees to transport or deliver the goods within a 
prescribed time, he is bound by his contract, and is conse¬ 
quently liable for his failure to do so. 

Liability under Special Contract 

Although the general liability imposed by law upon the 
common carrier of goods is that of an insurer, it is possible for 
the carrier, by special contract, to limit his liability to the loss 


CARRIER’S LIABILITY FOR GOODS IN TRANSIT 379 

or damage resulting from his negligence. In such a case the 
shipper makes out a prima facie case of liability against the 
carrier by proving the loss or injury to the goods, and the 
burden of proof then rests on the carrier to prove that the 
loss or damage did not result from negligence on his part. 

But the limitation of the carrier’s liability as an insurer of 
the goods can be effected only by means of a contract assented 
to by the shipper. Notices limiting his liability as such are 
ineffectual unless the shipper assents to the terms of such 
notice, and such assent cannot be inferred merely because the 
shipper, after he has knowledge of the notice, delivers the 
goods to the carrier for shipment. 

On the other hand, whereas the limitation of the carrier’s 
liability must be by contract, it is not essential that the con¬ 
tract should be in any special form. For example, acceptance 
by the shipper of a bill of lading, or similar instrument, pur¬ 
porting generally to contain the contract between the carrier 
and shipper, creates a contract binding on both parties. Ex¬ 
press receipts stand upon the same general footing as bills of 
lading, and when accepted without objection, they, too, consti¬ 
tute the contract between the parties. In fact, the practice of 
incorporating the term of shipment in such receipts has be¬ 
come so general that they are no longer distinguishable in this 
respect from bills of lading. 

Contracts limiting the general liability of the carrier are 
construed strictly against the carrier. Where the carrier seeks 
to escape liability on the ground that the loss or injury to the 
goods was due to causes as to which he is exempt under the 
contract, the burden of proof rests upon the carrier to bring 
such loss or injury within his contractual exemption. 

Absolute Liability for Negligence 

Whereas the carrier may, by contract, limit his extreme 
common law liability, whereby he was held liable as an insurer 
of the goods, it is equally clear that the carrier cannot by con- 


RIGHTS AND REMEDIES OF CREDITORS 


380 

tract relieve himself from liability for loss or damage due to 
his negligence, or that of his agents or servants, on the ground 
that the public nature of the employment is such as to render 
such contracts contrary to his fundamental obligation to the 
public, and therefore against public policy. 

Stipulations limiting the recovery for loss or damage to a 
specified amount are clearly valid in the absence of negligence 
on the part of the carrier or his agents. But where the loss 
is due to the carrier’s negligence, such limitations are invalid. 
In other words, in such a case the shipper may, in spite of 
the stipulation limiting the carrier’s liability to an arbitrary 
amount, recover the full amount of damage that has been suf¬ 
fered as the result of such negligence. 

Limitation as to Time in Submitting Claims 

The carrier may by contract require that claims for dam¬ 
ages be presented in a certain prescribed manner, and within 
a specified time, and the contract will be valid, provided such 
stipulation as to time and manner be reasonable. 

Commencement and Termination of the Liability 

The extraordinary liability of the common carrier of goods 
attaches only from the time when the goods are delivered to, 
and accepted by, the carrier for immediate transportation. The 
acceptance of the goods may be implied, although generally 
express, as where the goods are left in a certain place in ac¬ 
cordance with the contract of the carrier thus to receive them, 
or in accordance with an established custom or usage. Proof 
of delivery and acceptance by the carrier may be made by any 
available means sufficient to support the action. Such evi¬ 
dence, however, is usually incorporated in the bill of lading 
acknowledging receipt of the goods. 

The common carrier’s liability is terminated when the 
transportation is completed and the carrier has delivered the 
goods either to the consignee or to a connecting carrier in 


CARRIER’S LIABILITY FOR GOODS IN TRANSIT 381 


accordance with the terms of the contract. To constitute a 
valid delivery the goods must have been delivered 

1. To the proper person. 

2. At a proper time. 

3. At the proper place. 

4. In a proper manner. 

The common carrier of goods is an insurer as to the 
delivery of the goods to the person to whom they are consigned, 
and for any mistake in this respect the carrier is absolutely 
liable, regardless of the question of the care or diligence he 
has used. 

The carrier’s liability as an insurer of the goods continues 
only so long as the goods remain in transit, and thereafter his 
liability is that of a warehouseman. In the case of carriers 
by water, the transit has been held to be terminated after the 
goods have arrived at destination, notice of such arrival has 
been given to the consignee, and a reasonable time has been 
granted him within which to receive the goods. 

As for railroads, the courts have laid down three different 
rules or doctrines: 

1. Under the Massachusetts rule the transit has been held 

to end when the goods have arrived at their destina¬ 
tion and have been stored by the carrier. 

2. Under the New Hampshire rule, when, after the arrival 

and storage of the goods a reasonable time has elapsed 
within which the consignee could have received the 
goods. 

3. Under the Michigan rule, only when, after the arrival 

of the goods, notice has been given to the consignee 
and a reasonable time for their removal has elapsed 
after such notice. 

Refusal to Accept by Consignee 

The duty of the consignee to receive the goods is as clear 
as the carrier’s duty to deliver. The strict liability of the 


382 


RIGHTS AND REMEDIES OF CREDITORS 


common carrier cannot be prolonged at the option of the con¬ 
signee, and the consignee must act with reasonable promptness 
in taking delivery of the goods. If he fails to do so the car¬ 
rier’s liability as an insurer is thereby terminated. 

Delivery to a Connecting Carrier 

The law is neither well established nor uniform as to the 
liability of the common carrier of goods when the complete 
transit from shipping point to destination is over the lines 
of connecting carriers. However, if any general rule may be 
laid down, it is that: Where the goods are received by a 
carrier to be transported over connecting lines, the initial car¬ 
rier is not liable for loss or injury occurring beyond its own 
lines, unless by special contract an obligation is assumed to 
convey the goods to their destination. The question is further 
complicated by statutes, both state and federal, most of which, 
like the Federal Interstate Commerce Act, render the initial 
carrier liable for loss or damage occurring on the lines of the 
connecting carrier. 

As to whether or not the carrier intended to limit his lia¬ 
bility to the carrier’s own line, is often a question concerning 
which the following circumstances have been held to consti¬ 
tute evidence, though not conclusive, from which a contract for 
through transportation may be inferred: the use of the words 
“to be forwarded” in the carrier’s receipt; issuing of a bill of 
lading or receipt which purports to be a through contract; the 
giving of a through rate; prepayment of freight for the whole 
transportation; the carrier’s holding out to carry over the 
whole distance; or an agreement that the goods be carried 
through to ultimate destination in a particular car. 

When the goods are received by a carrier to be transported 
to a point beyond its own line, under circumstances which 
make the initial carrier liable as an insurer only to the end of 
its own line, there devolves upon him the additional duty to 
deliver the goods safely to the connecting carrier. 


CARRIER’S LIABILITY FOR GOODS IN TRANSIT 383 

Liability for Goods Lost or Damaged in Transit 

When goods are lost or damaged in transit over connecting 
lines, the consignor has ordinarily no means of showing on the 
line of which carrier the loss or damage occurred, and as an aid 
and protection to shippers in presenting their claims under 
such circumstances, the law has created certain presumptions 
in his favor. 

In the case of damage to, or a partial loss of goods, the 
presumption is that the loss or damage is attributable to that 
carrier in whose possession the goods are found in a damaged 
condition, or with part of the goods missing, which simply 
means that the presumption is as a rule invoked against the 
last carrier. This doctrine is based on the theory that once 
a proper and complete delivery has been made to the initial 
carrier by the shipper, such a state of facts continues to exist 
until the contrary is shown to be true. In other words, it is 
a mere presumption which has the effect of shifting the burden 
of proof from the shipper to the last carrier. 

The same rule has been held to apply also when there has 
been a total loss of the goods, although it would seem to be 
unjust to hold such carrier liable in the absence of proof that 
the goods ever came within his possession. In the case of a 
total loss it would seem more reasonable at least, as Professor 
Dobie, of the University of Virginia points out, in fixing the 
liability, to start with the liability of the initial carrier and work 
forward through the intermediate carriers, than to start with 
the last carrier and work backward. 

Excuses for Non-Delivery 

The common carrier is excused for failure to deliver 
the goods to the consignee under the following three circum¬ 
stances : 


1. When the goods are demanded by one having a para¬ 
mount title to them. 


384 


RIGHTS AND REMEDIES OF CREDITORS 


2. When the shipper, owing to the insolvency of the buyer, 

has exercised the right of stoppage in transit, or the 
goods have been taken by some judicial process. 

3. Where the goods, in the absence of negligence, have 

been lost, owing to one of the previously mentioned 
excepted perils. 

The carrier is estopped, by virtue of the bailment, from 
denying the title of the shipper at the time of delivery and 
acceptance of the goods for shipment, and the carrier must 
deliver the goods, unless legally excused, at the termination 
of the transit, according to the shipper’s instructions. Conse¬ 
quently, if notice of an adverse claim to the goods is served 
upon the carrier by a third party, the validity of this claim 
must be determined by the carrier on his own responsibility. 
He cannot disregard the claim, and if he does deliver the 
goods to the designated consignee the carrier is liable to the 
adverse claimant, if his claim proves to be a just one. Again, 
if the carrier delivers the goods to the adverse claimant he 
thereby becomes liable to the shipper should such claim later 
prove invalid. 

When, however, the claim made by the third party is 
well founded the carrier is not only justified in making de¬ 
livery to* such claimant, but is bound to make such delivery, 
and consequently excused from making delivery to the con¬ 
signee designated by the shipper. Thus the carrier, when sued 
by the consignee for non-delivery, has a perfect defense in 
having delivered the goods to one having a paramount title to 
them, but it has been held that in order to justify delivery to 
the true owner, contrary to or without the shipper’s orders, 
the carrier has the burden of proving the ownership and 
immediate right of possession in the person to whom such 
delivery is made. 

The question as to the right of the shipper to stop goods 
in transit, based upon the insolvency of the consignee, has been 
discussed in a preceding chapter. (See Chapter XXV.) 


CARRIER’S LIABILITY FOR GOODS IN TRANSIT 385 

Liability for Carrier’s Compensation 

A common carrier is given a lien on goods in his posses¬ 
sion; that is, if the owner or consignee fails to pay the trans¬ 
portation charges of the goods, the carrier may retain pos¬ 
session of them until such payment is made. 

The consignor is primarily liable for the carrier’s com¬ 
pensation inasmuch as it is he who is instrumental in induc¬ 
ing the carrier to accept the goods for transportation. There 
is a presumption, however, that the consignee is liable for the 
carrier’s charges as the owner of the goods in whose behalf 
the consignor was acting. In accepting the goods from the 
carrier, the law ordinarily implies a promise on the part of the 
consignee to pay the freight charges, and that in surrendering 
the goods to the consignee the carrier obtains the right to look 
to such consignee for his compensation. This being a mere 
presumption of ownership in the consignee, it is rebuttable, 
and if the consignee is proved not to be the owner of the goods, 
he is not liable merely because another consigns goods to him, 
if he does not accept them. 

It is usual for the bill of lading covering the shipment to 
prescribe the mode of payment of the freight charges, and in 
such cases it matters not whether the consignee be the owner 
or not, or whether the consignor is also liable for the freight. 
If, however, the consignee, before the goods are delivered to 
him, indorses the bill of lading to another, who receives the 
goods, it is held that the carrier must look to such assignee 
(and not to the consignee) for payment of his charges, unless 
such assignee is acting in the capacity of an agent for the con¬ 
signee. 

Demurrage and Storage 

In the case of a carrier by rail, when the duty of unloading 
the goods from the car in which they have been shipped rests 
upon the consignee, the railroad is entitled to recover demur¬ 
rage when the consignee detains the car for an unreasonable 


3 86 


RIGHTS AND REMEDIES OF CREDITORS 


time, owing to his failure to unload the car with reasonable 
despatch, even in the absence of an express contract. Further¬ 
more, if the consignee does not accept delivery of the goods 
within a reasonable time, the carrier may either turn the goods 
over to a warehouseman, or the carrier may itself store the 
goods. In such a case, either the warehouseman or the carrier 
is entitled to collect reasonable storage charges for such service. 

Discrimination in Rates 

Under the common law, discrimination in rates by the com¬ 
mon carrier of goods, in the sense of giving a lower rate to 
one shipper than to another, was not prohibited, provided both 
rates were reasonable, and provided the discrimination was 
not for an illegal purpose. The present-day tendency, how¬ 
ever, is to prohibit such discrimination by insisting upon 
an equality of rates as well as reasonableness, and both state 
and federal statutes have been enacted prohibiting any dis¬ 
crimination in rates as illegal, because of the absolute depend¬ 
ence of the public on the modern carrier. 

The Carrier’s Lien 

Since the common carrier of goods is compelled to serve 
all who apply, he is given adequate methods of insuring the 
payment of his charges, inasmuch as he : (I ) may demand pay¬ 
ment in advance, and (2) has also a lien on the goods carried 
to secure the payment of his compensation. 

Like other liens, the lien of a carrier is a personal privilege 
and cannot be assigned. The lien is not lost, however, by the 
carrier turning the goods over to a warehouseman to be stored 
until the carrying charges are paid,’ for in such cases the ware¬ 
houseman is merely the agent of the carrier, and his possession 
is treated as the possession of the carrier. The carrier’s lien is 
a special lien, meaning it attaches only to the specific goods 
carried. Nor can the carrier hold the goods to enforce the 
payment of a general balance arising out of a series of simi- 


CARRIER’S LIABILITY FOR GOODS IN TRANSIT 387 

lar shipments, or for debts on other consignments previously 
incurred by the shipper. 

A carrier, however, has no lien on goods delivered for 
transportation by one who is a wrongdoer, and who has no 
authority to deliver the goods to the carrier. This, of course, 
works a great hardship on the carrier, since he is bound to re¬ 
ceive and carry goods tendered to him for transportation; but, 
on the other hand, it is his privilege, as we have seen, always 
to insist upon payment for the carriage of the goods in advance. 

Sale under the Lien 

At common law the carrier was given no right to sell the 
goods held under such a lien, but merely the right to hold the 
goods until the carrying charge was paid, or resort to suit and 
sale under execution proceedings. Statutes have been passed 
in nearly all the states, however, empowering the carrier to 
sell the goods held under the lien for his charges after he has 
held them a reasonable time, without the necessity of resort¬ 
ing to suit. 

4 

Rights of Action against Carriers of Goods 

The responsibility imposed by law upon the common car¬ 
rier of goods is readily apparent from the various rights of 
action to which he is subject for a failure properly to perform 
his duties as such. The following rules have been laid down 
as governing the rights of action which may be maintained 
against the carrier for the loss of, injury to, or delay in trans¬ 
porting the goods: 

1. Where the contract for transportation is directly with 
the consignor, the consignor, whether or not he retains any in¬ 
terest in the goods, may maintain an action on the contract 
for any breach thereof; but the recovery is for the benefit of 
the consignee if the latter is the real owner of the goods. 

2. It is to be presumed that the consignee is the owner of 
the goods and is therefore the person with whom, through the 


3 88 


RIGHTS AND REMEDIES OF CREDITORS 


agency of the consignor, the contract is made. Hence, the 
consignee can sue on the contract for any breach thereof result¬ 
ing in the loss of, or damage to, the goods. But the presump¬ 
tion may be rebutted. 

3. The person at whose risk the goods are carried, that is, 
the person having a general or special property in the goods, 
and who will therefore suffer if the goods are lost or injured, 
may maintain an action in tort for such loss or injury. 

When the contract of shipment is made with the consignor, 
the consignee, having no interest in the goods, incurs no risk 
in the transportation, and cannot therefore maintain an action 
against the carrier. He cannot sue on the contract, for the 
contract is not made in his behalf. Neither can he sue in tort, 
for the carrier’s duty is not owed to him and he suffers no 
injury when there is a breach of the duty. The consignee 
under these circumstances is barred from maintaining any 
action against the carrier. 

Measure of Damages 

Certain well-established general rules have been laid down 
as governing the measure of damages to be recovered in action 
against the common carrier of goods for— 

1. His refusal to accept and transport the goods. 

2. Actions for the loss of, or injury to the goods. 

3. Actions for delay in transporting the goods. 

The principle underlying these general rules is that in 
determining the amount of damages to which the plaintiff is 
entitled in an action for breach of duty by the carrier, the law 
seeks to put the plaintiff in the position in which he would 
have been had the carrier fully performed his duty. Punitive 
damages are rarely given. 

1. The ordinary measure of damages in an action against 
the carrier for his wrongful refusal to accept and transport 
the goods, is the difference between what would have been the 


CARRIER’S LIABILITY FOR GOODS IN TRANSIT 389 

value of the goods at the place where and the time when they 
should have been delivered, and their value at the time and 
place of refusal, less the transportation charges. 

2. The measure of damages for the total loss or non-deliv¬ 
ery of the goods is the value of the goods at the time when 
and at the place where they should have been delivered, less any 
unpaid transportation charges. The measure of damages for 
injury to the goods in transit is the difference between the value 
of the goods at the time and place of delivery in their damaged 
condition, and what their value would have been had they been 
duly delivered in good order, less any unpaid transportation 
charges. 

3. The measure of damages for the delay or non-delivery 
of the goods is the difference between the value of the goods 
at the time when and the place where they should have been 
delivered and their value at the time and place of actual de¬ 
livery, less any unpaid transportation charges. When, how¬ 
ever, the value of the goods is not diminished by the delay, 
the measure of damages, after unpaid transportation charges 
are deducted, is the value of the use of the goods during the 
period of delay. 

Special damages arising from the carrier’s default are ordi¬ 
narily not allowed unless the peculiar circumstances out of 
which these damages arise are communicated to, or known by, 
the carrier, and unless these damages are also the natural and 
probable consequence of the carrier’s breach of duty. 1 

The Interstate Commerce Commission 

Article 1, section 8, of the United States Constitution gives 
Congress the power to regulate commerce, by providing that: 

Congress shall have power to regulate commerce with foreign 
nations and among the several states and with the Indian tribes 
.... and to make all laws which shall be necessary and proper 
for carrying into execution the foregoing powers. 

>Consult Dobies’ “Bailments and Carriers” for a more detailed and complete treatment of 
the subject. 



390 


RIGHTS AND REMEDIES OF CREDITORS 


The United States Congress enacted the original Inter¬ 
state Commerce Act, entitled “An Act to Regulate Commerce,” 
on February 4, 1887, which has now been on the statute books 
for 35 years, although the scope of the original act has been 
greatly extended by the numerous amendments since made. 
The act provides for the creation of an Interstate Commerce 
Commission to consist of seven members, each of whom is to 
receive a salary of $10,000 a year. 

The act makes it compulsory for all common carriers en¬ 
gaged in interstate or foreign commerce to publish a schedule 
of their charges for carrying goods or property and if the 
Commission finds that a rate is unreasonable, it is empowered 
to prescribe a reasonable one. Carriers who deviate from this 
schedule, or who give rebates or discriminate between ship¬ 
pers in any way are subject to being fined and. the responsible 
officers and agents are subject to imprisonment. The Com¬ 
mission is further empowered to investigate the profits of the 
carriers and to fix the maximum and minimum rates for car¬ 
riage in the proper proportion thereto. 

Under this act it is the privilege of shippers who are in any 
way discriminated against to file a formal complaint with the 
Commission, and the Commission may then conduct an investi¬ 
gation of the facts set forth in the complaint in much the same 
capacity as a court of law, and award damages to the injured 
party. If the carrier then refuses to comply with the decision 
of the Commission, the latter may invoke the machinery of 
the United States courts to enforce its order. When this is 
done, the finding of the Commission is held to constitute a 
prima facie case. 

Section 20 of the act expressly prohibits carriers engaged 
in interstate commerce from relieving themselves from lia¬ 
bility by special provisions incorporated in their bills of lading 
which previously had become quite common and the effect 
of which was to evade their common law liability as common 
carriers. 


CARRIER’S LIABILITY FOR GOODS IN TRANSIT 


391 


Any common carrier, railroad or transportation company 
receiving goods for transportation from a point in one state to 
a point in another, shall issue a receipt or bill of lading therefor, 
and shall be liable to the lawful holder thereof for any loss, 
damage or injury to such property caused by it, or by any 
common carrier, railroad or transportation company to which 
such property shall be delivered, or over whose lines such prop¬ 
erty may pass: and no contract, receipt, rule or regulation shall 
exempt such common carrier, railroad or transportation company 
from the liability hereby imposed: provided that nothing in this 
section shall deprive any holder of such receipt or bill of lading 
of any remedy or right of action which he has under existing law. 

Proceedings before the Commission 

Under the act creating it the Commission is vested with 
the power of hearing evidence and determining what are rea¬ 
sonable practices and rates of transportation. But how does 
the complaining shipper proceed to call the attention of this 
tribunal to his particular grievance and invoke the operation 
of this governmental force? 

In the first place the Commission is not a court, but func¬ 
tions as an arm of Congress and therefore belongs to the 
legislative branch of government. This is but natural since 
it is to Congress that the Constitution grants the power to 
regulate commerce between the states. 

Presentation 

The act itself sets forth very simple rules of pleading and 
evidence. It provides that any person, firm, or corporation 
may file a petition briefly stating the facts complained of. 
The Commission is then required to send a copy thereof to the 
carrier who must file an answer in writing. The policy of the 
Commission has always been that the practice before it shall be 
as simple and devoid of technicalities as possible. 

The Commission is then empowered to investigate the 
matter and is required to give all parties in interest a full public 
hearing. The procedure involved in the consideration of 


392 


RIGHTS AND REMEDIES OF CREDITORS 


each case is characterized in the formal wording of the order, 
as follows: 

This case being at issue, upon complaint and answers on file, 
and having been duly heard and submitted by the parties, and 
full investigation of the matters and things involved having 
been had, and the Commission having made a full report con¬ 
taining its findings of fact and conclusions thereon, it is ordered 
that j « ■ • 

Hearing 

The case is heard either by a commissioner in person or by 
an “examiner.” Owing to the increased scope and pressure of 
business before the Commission, comparatively few cases are 
heard before the commissioners, although when it was first 
organized such was the usual practice. However, if the case 
is one of importance, the parties, upon application to the Com¬ 
mission by letter, may obtain an opportunity to argue the case 
orally before the entire Commission in Washington. 

As a rule, the decisions of the Commission are rendered 
and published within six months from the date of filing the 
complaint, and the law requires the Commission to serve a 
copy of its opinion and order upon the parties in the case. 2 

Uniform Bills of Lading Acts 

The effect of the measures provided for in the act creating 
the Interstate Commerce Commission was to break up state 
regulation of a growing commerce, which was in fact inter¬ 
state or national. No provision was made at the time, how¬ 
ever, for the standardization of bills of lading to be used by 
the carriers in handling such interstate commerce, thus leaving 
to each state the right to exercise its independent judgment as 
to this aspect of the law of carriers, through its courts and 
legislative body. 

In other words, the states still preserved authority to 

s See “Lectures on Procedure before the Interstate Commerce Commission,” by C. R. 
Hillyer. 



CARRIER’S LIABILITY FOR GOODS IN TRANSIT 


393 


determine the nature of the bills of lading to be used within 
their respective territories. In order, therefore, to offset the 
many disadvantages accruing from a wide diversity of terms 
and stipulations contained therein, the Uniform Bills of Lad¬ 
ing Act was drafted by the Commission on Uniform State 
Laws in 1909 and submitted to the various states for adop¬ 
tion. It has since been adopted by the following states: 


Alaska, 1913 
California, 1919 
Connecticut, 1911 
Idaho, 1915 
Illinois, 1911 
Iowa, 1911 
Louisiana, 1912 
Maine, 1917 
Maryland, 1910 
Massachusetts, 1910 
Michigan, 1911 
Minnesota, 1917 


Missouri, 1917 
New Hampshire, 1917 
New Jersey, 1913 
New York, 1911 
North Carolina, 1919 
Ohio, 1911 
Pennsylvania, 1911 
Rhode Island, 1914 
Vermont, 1915 
Washington, 1915 
Wisconsin, 1917 


The principal advantage accruing from the adoption of 
such a standard form is that shippers in the states which have 
adopted this act need not scan each form to ascertain whether 
it contains any new terms, requirements, or responsibilities. 

In 1916 an act 3 was passed by the federal legislature (sub¬ 
stantially the same in terminology as the Uniform Bills of 
Lading Act) providing for the use of a standard or uniform 
bill of lading in the transportation of interstate commerce. 
As a result of this act, the same statutory rules and regulations 
now governing bills of lading in the states above mentioned 
likewise apply to the transportation of all interstate commerce, 
which is defined under the federal act as the transportation of 
merchandise “from a place in one state to a place in another 
state; or from a place in a state to a place in a foreign country; 
or, from a place in one state to a place in the same state through 
another state, or foreign country.” 


3 39 Stat. L. 538. 




PART VI 


CREDIT AS A MEDIUM OF EXCHANGE 







CHAPTER XXXII 


ASSIGNMENT OF BOOK ACCOUNTS 

Credit Instrument Defined 

The world’s gold supply is insufficient to meet the current 
demands of trade, even if used for no other purpose, and 
today all but a small portion of the world’s business is 
transacted by means of credit in some form or other serving 
as the medium of exchange. In other words, the economic 
necessities which have created the various kinds and forms 
of instruments of credit that are to be discussed in this chapter 
are nothing more than the ordinary requirements and practices 
which modern business has made indispensable So, the func¬ 
tion of credit in commerce is to act as a substitute for capital. 
The amount of actual money in circulation in the United States 
is approximately $4,500,000,000 or about $40 per capita, so it 
is obvious what the limitation on our commerce would amount 
to if all transactions were confined to a cash basis. 

The term “credit instrument” as used in the commercial 
world, may be defined as the evidence of an obligation to pay 
money or to deliver goods. The extent to which a credit 
instrument may serve as a substitute for money depends upon 
two things: (1) the nature of the obligation embodied in the 
instrument; and (2) the form of the instrument—whether it 
is negotiable or non-negotiable. 

Forms of Credit Instruments 

There are three forms of credit instruments, as follows: 

1. The nature of the obligation may be such that the 
instrument in which it is embodied is universally accepted in 


397 


CREDIT AS A MEDIUM OF EXCHANGE 


398 

the country of issue as a substitute for money, and therefore 
constitutes what is termed credit of “general” or “unlimited 
acceptability, e.g., federal reserve notes, bank notes, and silver 
certificates. 

2. The nature of the obligation embodied in the instru¬ 
ment may be such as to limit its use as a medium of exchange 
to a restricted field. Such instruments constitute what is 
termed credit of “limited” acceptability, e.g., promissory 
notes, checks, drafts, bills of exchange, trade acceptances, 
bills of lading, warehouse receipts, and letters of credit. 

3. The nature of the obligation may be such that instead 
of being embodied in, or evidenced by, some credit instrument 
which may be conveniently transferred from hand to hand, 
it is evidenced merely by a “credit” upon the books, or a book 
account, e.g., book accounts used by the seller of merchandise 
when he sells goods to a customer. 

Book Accounts 

Consideration will be given in this chapter to book accounts, 
which constitute probably the earliest as well as the most simple 
form of commercial credit. Nowadays, in most all instances 
when merchants buy from each other, the only evidences of the 
sale expressed are the entry of the charge in the ledger of the 
seller and the invoice for the amount of the goods sent to the 
seller, which when paid closes the transaction. The convenience 
afforded by this character of credit is readily apparent, but 
at the same time it is also apparent that the book account does 
not perform the same useful function in the commercial world 
as the other kinds of credit instruments, of which the seller may 
avail himself almost immediately and either purchase addi¬ 
tional supplies or use it as the basis for obtaining additional 
credit. Yet the book account is as valuable a credit instrument 
as any that is used. It may be sold or assigned, and the pur¬ 
chaser or assignee thereof receives the same right of action 
against the debtor that the original creditor had. In other 


ASSIGNMENT OF BOOK ACCOUNTS 


399 


words, there are ways in which book credits may be used in 
lieu of other collateral for the purpose of securing funds. 

Methods of Assignment 

Non-Notification Plan. A merchant may assign his 
accounts to a bank or a commission house, and in return be 
permitted to withdraw a certain percentage of the value of the 
accounts thus assigned. Under this plan the merchant’s 
creditors are not advised of the assignment of their accounts 
to the bank, and the merchant is permitted to act somewhat 
in the capacity of an agent of the bank to collect the accounts 
in the usual manner and to use the funds thus’collected. As 
soon as the account is collected, however, the merchant must 
assign other accounts of equal value to the bank in order that 
the ratio, or margin, originally agreed upon between the total 
book value of the accounts pledged and the amount of the loan 
negotiated may be maintained, that is, assuming that the mer¬ 
chant has not promised to apply directly all receipts from such 
accounts to the reduction of the loan. Failure on the part 
of the merchant thus to account for such collections might 
render him criminally liable if done intentionally to defraud 
the bank. This is commonly known as the “non-notification” 
plan. 

The usual and most simple form of assignment is as 
follows: 

For Value Received, I (cr we) hereby sell, assign, transfer, 

and set over unto . all my (our) right, 

title and interest in and to the within (annexed, or foregoing) 
accounts. 

(Signature) 

Notification Plan. Another method of assigning book 
accounts consists of a similar assignment of accounts receivable 
by the merchant to the bank and a notice of the assignment 
being sent to all debtors whose accounts have been assigned, 




400 


CREDIT AS A MEDIUM OF EXCHANGE 


together with a request that they remit direct to the bank. In 
such cases it is also customary to stamp all subsequent invoices 
with a notice to the effect that the account has been assigned 
and is payable to the bank specified in the notice. This method 
is known as the “notification plan.” In other words, the assign¬ 
ment may be made openly or secretly. 

This second method of raising needed capital by pledging 
book accounts is not, of course, so favorable to the merchant, 
inasmuch as the merchant’s business reputation suffers some¬ 
what as a result of his customers being informed of the 
assignment, whereas under the other plan the fact of the assign¬ 
ment is kept from the knowledge of the customers. 

Not being considered to be a high class of collateral security, 
the rate of interest on such loans is generally higher than the 
prevailing rate on other kinds of collateral security, and, in 
addition, a bonus is generally charged for the accommodation, 
the specific terms under which such loans are negotiated varying 
in accordance with the nature and character of the accounts. 
Consequently, the handling of this kind of collateral affords 
a profitable source of revenue to the bank, and many banking 
houses have established special departments to handle this 
character of business. Viewed from the standpoint of the 
merchant, however, the opposite may be said to be true, because 
present-day competition is too keen to permit the average mer¬ 
chant to pay an exorbitant rate of interest together with 
a bonus for the use of such additional funds in his business. 
Such a practice is bound eventually to leave undesirable effects 
in its wake. 

Purposes for Which Accounts Are Assigned 

There are times, however, when the practice may be profit¬ 
ably taken advantage of by a merchant. For example, the 
discount rate on a purchase may exceed the borrowing rate on 
accounts receivable, thus making it a paying proposition for 
a merchant to borrow money on his open accounts with which 


ASSIGNMENT OF BOOK ACCOUNTS 


401 


to discount the purchase. The way to determine whether or not 
a merchant can save money by assigning his accounts receivable 
to obtain funds with which to discount his bills is shown in the 
following two illustrations: 

1. Suppose the purchase amounts to $5,000; the terms of 
payment are 30-1-10; and the borrowing account on open 


accounts is 15 per cent. 

1 per cent discount. $50.00 

$4,950 for 20 days at 15 per cent. 40.60 

Assigning merchant saves. $9.40 


This is hardly a paying proposition, considering the time 
and trouble incidental to negotiating the loan. 

2. Suppose, however, the terms of payment were 30-2-10: 


2 per cent discount. $100.00 

$4,900 for 20 days at 15 per cent. 40.20 

Assigning merchant saves. $59.80 


Here he saves between 6 and 7 times as much as in the 
former case. 

It is also true that most merchants find themselves hard- 
pressed for ready funds at some time or other, and it is often 
possible for them to obtain temporary relief by assigning their 
accounts receivable when the funds necessary to tide them over 
their period of embarrassment cannot be obtained in any other 
manner. 

Objections to the Assignment of Accounts 

Although the ease with which additional funds can be 
obtained in this manner presents a constant temptation to the 
small merchant to overtrade, the main objection to the practice 
is that it affords an opportunity for dishonest merchants to 
mislead their creditors as to the true status of their financial 
condition until it is too late for the creditors to protect them¬ 
selves. It not infrequently happens that the first notice credit 










402 


CREDIT AS A MEDIUM OF EXCHANGE 


men receive of such an assignment is when the debtor fails 
and it is found that the good accounts have already been trans¬ 
ferred. This situation would be largely avoided and credit 
men properly protected if such transfers were required by 
law to be recorded, as in the case of conditional sales agree¬ 
ments and chattel mortgages, in order to make them valid as 
against creditors. 

The National Association of Credit Men has for years been 
advocating such legislation to provide: 

1. For the recording of such transfers in an office of public 

record. 

2. That notice be given to debtors whose accounts have 

been assigned. 

3. And in event these provisions are not complied with, 

that such secret transfers or assignments shall be void 

as against creditors. 

Under the rulings of the Federal Reserve Board the assign¬ 
ment of an open account does not come within the meaning of 
the term “negotiable paper” and is not eligible for rediscount 
by a federal reserve bank. 


CHAPTER XXXIII 


NEGOTIABLE INSTRUMENTS AND DOCUMENTS 

OF TITLE 

Non-Negotiable and Negotiable Instruments 

Having considered the manner in which mercantile credit 
in its most simple form of the book account may serve as a 
medium of exchange for obtaining credit, we come now to the 
consideration of our second class of credit instruments, or 
the extent to which such indebtedness may serve as a medium 
of exchange, or substitute for money, when the obligation 
of the debtor is evidenced by, and embodied in, some written 
instrument, e.g., a “promissory note” wherein the debtor 
expressly promises to pay the amount of the debt or account 
at maturity. 

The extent to which such instruments function in the com¬ 
mercial world as a medium of exchange depends primarily 
upon the nature of the instrument in which the obligation is 
embodied—whether it manifests an intention on the part of 
the debtor to bind himself for the amount of the instrument 
to the creditor alone; or also to whomsoever the creditor may 
wish to transfer it. In the one case the instrument is said to 
be non-negotiable, and in the other, negotiable. 

As to whether the debtor intended the one or the other is 
determined by the words used in specifying the payee of the 
instrument. If it is a mere promise to pay A, the naming of A, 
and A alone, operates to the exclusion of all others; whereas, 
if it is a promise to pay “A or order,” the additional words 
“or order” constitute the necessary words of negotiability and 
manifest an intent on the part of the debtor to obligate himself 


403 


404 


CREDIT AS A MEDIUM OF EXCHANGE 


not only to A, but also to whomsoever A may wish to transfer 
the obligation. 

Distinction between Assignability and Negotiability 

The early conception of a contract relation was that the 
agreement created a strictly personal obligation which could 
not be transferred to another; but later the privilege of assign¬ 
ing their rights under the contract was extended the contract¬ 
ing parties by the courts whereby the assignee was permitted 
to sue in the name of the assignor but whatever defenses could 
be set up against the assignor (one of the original parties to 
the contract) could be interposed against the assignee, and in 
a modified way this is substantially true today as to ordinary 
contracts. 

Hence, it is readily apparent that if written evidences of 
debt were to play a very important part in the commercial 
world, holders of such instruments must be saved the time 
and trouble of investigating their validity and afforded pro¬ 
tection in the enforcement of them, which has gradually been 
accomplished by formulating a special set of rules with a view 
to facilitating the transfer of a special class of written con¬ 
tracts called “negotiable instruments.” 

This fundamental distinction may be illustrated as follows: 

1. Suppose A has a horse in his stable. B steals it and sells 
it to C. It is still A’s horse and he can demand its immediate 
return from C. Why? Because B never had a good title to 
the horse to pass on to C. 

2. Suppose A indorses a check in blank, leaves it lying on a 
table, and B steals it. B is a thief in both instances and no 
more a rightful owner of the check than he was of the horse. 

But suppose he tenders it to C in payment for a bill of goods and 
C, in good faith and not knowing it was stolen, accepts it in 
payment. A cannot go to C as he did in the first case and say. 
“That check you cashed was stolen from me and I want my 
money.” Why not? Because the law will protect the holder 
of a negotiable instrument when under similar circumstances it 
will refuse protection to holders of non-negotiable instruments 


NEGOTIABLE INSTRUMENTS 


405 


and other kinds of property for the same reason it refused to 

protect C in the first example. 

So, when we speak of an instrument as being negotiable 
we mean one capable of being transferred from one person to 
another in such manner as to constitute the one receiving it the 
true owner thereof with as good, or, as we have seen, an even 
greater right to enforce the obligation than the one he receives 
it from. 

Origin of Negotiable Instruments 

The negotiability of these instruments as a medium of 
exchange actually originated in the custom of merchants prior 
to the eighteenth century, when they came to' be recognized 
and enforced by the law courts (1705). By “custom of mer¬ 
chants” is meant a body of usages and rules relating to trade 
which grew up among merchants and which the law courts 
have since endeavored to enforce by affording protection to 
persons accepting them as a circulating medium of exchange— 
the primary object of negotiability being to give a certain class 
of contracts the same function which money plays in com¬ 
mercial transactions. 

Requisites of Negotiability 

How can we determine whether a certain instrument is 
negotiable or not? To be negotiable it must conform to the 
following requirements: 

1. It must be in writing and signed by the maker or drawer. 

2. Must contain an unconditional promise, or order, to pay 

a sum certain in money. 

3. Must be payable on demand or at a fixed or determin¬ 

able future time. 

4. Must be payable “to order” or “to bearer.” 

5. Instrument must be specific as to all parties concerned. 

6. Must be delivered. 

I. The first requisite needs no explanation. 


406 


CREDIT AS A MEDIUM OF EXCHANGE 


2. The reason the promise or order to pay must be uncon¬ 
ditional and payable at all events is to facilitate its circulation. 
If the promise or order was dependent on a certain contingency, 
the uncertainty as to whether that condition would be fulfilled 
would tend to restrict its negotiability. Likewise the sum of 
money to be paid must be definitely specified or capable of being 
calculated by an almost mechanical computation, such as figur¬ 
ing the interest. 

3. Were there any doubt as to when or whether the money 
will ever be paid, the negotiability of the instrument would 
be destroyed. 

4. The words “to order” or “to bearer” constitute the 
necessary indicia of intention of the maker that it shall pass 
freely from hand to hand, and no instrument is negotiable that 
does not contain the one or the other. 

5. The names of the parties to a negotiable instrument must 
appear on the face of the instrument and must be certain. An 
instrument whereby A promises to pay, but which is signed “A 
or B,” is not a promissory note. One reading, “I promise 
to pay $300 on demand for value received,” and signed with¬ 
out stating to whom payment is to be made is not a good 
promissory note. 

6. Delivery means transfer of possession with intent to 
transfer title. In other words, the mere writing and signing 
of a negotiable instrument creates no obligation or right of 
action whatever until it is delivered. 

Non-Essentials 

Particular note should be taken of the fact that the validity 
and negotiable character of an instrument are not affected by 
the fact that: 

1. It is not dated. 

2. It does not specify the consideration given or that any 

consideration was given. 


NEGOTIABLE INSTRUMENTS 


407 


3. It does not specify the place where it is drawn or place 
where it is payable. 

Promissory notes, drafts, checks, acceptances, bills of lad¬ 
ing* and warehouse receipts are real instruments of credit 
which can be used as a medium of exchange, or substitute for 
money. 

Forms of Negotiable Instruments 

A promissory note is an unconditional promise in writing 
signed by the maker, to pay absolutely and at all events a 


$.. 25.00 . . September 1 . 19 .22. 

. Thirty days .after date. I .promise 

to pay to the order of. Malcolm Kemper . 

. Twenty five ($25.00) .Dollars 

at. Louisville, Ky . 

Value received 

No. ..-.. Due . .October 1, '22 . Herbert C. Schwab . 

Form 20. Promissory Note 

sum certain in money either to the bearer or to a person therein 
designated or to his order (Form 20). With the exception 
of the bank check, the promissory note is the most common 
and perhaps the most widely used mercantile credit instrument. 
In form it may be made either negotiable or non-negotiable. 
If it is made payable “to . . . ., or order,” or “to bearer,” it is 
negotiable; whereas if it is made payable to a particular person 
only, it is non-negotiable. 

A draft is an unconditional order in writing by one person 
to a second person directing the payment to another of a sum 
of money absolutely and at all events. It must be formally 
accepted by the party on whom it is drawn before any obliga¬ 
tion is created. By “accepted” is meant that the party on whom 
the draft is drawn must signify his willingness to pay it by 
writing across the face of it “Accepted,” together with date 
and signature. 

















408 credit as a medium of exchange 

A bank draft is a bank’s check drawn upon some other bank 
in which it has funds on deposit or established credit. A com¬ 
mercial draft (Form 21) is an order made by one merchant 
upon another to pay a certain sum of money. Usually the 
payee in such instances is the drawer of the draft, although it 
may be some third party to whom the drawer is indebted. The 
draft may be made payable “at sight,” or “....days after 
sight.” The former is called a “sight” draft, the latter a “time” 
draft. 


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$.. 8 . 00 .. The Watson & Grove Co. 

Cincinnati, Ohio,. Feb. 29, 19.22.. 

. At sight . Pay to the order of ourselves 

.... Eight .Dollars 

Value received and charge to account of. . Inv. 11 /22/'22 .. . 
To .... Messrs. Bowers & Co.. The Watson & Grove Co. 

.... Chatham, N. J. . By . . . .R. B. Smith . 

A ss't Treas. 


Form 21. Commercial Draft 


Before being accepted a draft is not a credit instrument 
because there is no binding obligation embodied in the instru¬ 
ment—only a request by one party addressed to another (the 
drawee). After acceptance, however, the obligation of the 
drawee (party upon whom it is drawn) becomes the same 
as that of the maker of a promissory note. 



Cincinnati, 0 ., ... .August 23 ... .19.22. 
Merchants' National Bank 

No. .. 196 

Pay to the order of 

. James S. Bussey . 

$. .75-00 .. 

. Seventy-jive. . 

. Carl Phares . 



Form 22. Bank Check 


A check (Form 22) is a draft or order on a bank directing 
the payment on demand of a certain sum of money to a 


















NEGOTIABLE INSTRUMENTS 


409 


certain person named therein, his order, or to bearer—pur¬ 
porting to be drawn against funds of the drawer on deposit 
in the bank. Owing to the convenience it affords, the bank 
check has become the principal means of making payment for 
goods sold, and is used almost exclusively in the payment of 
larger amounts, or debts, in a distant city. 

The theory or principal underlying the use of bank checks 
is that the maker, or drawer, has sufficient funds on deposit 
with the bank upon which the check is drawn to cover the 
amount of the check. When, however, the bank refuses to 
pay the check because the maker has not sufficient funds on 
deposit, the check becomes a direct promise of the maker who 
may be liable upon it by the payee. 

When either the maker or payee of a check wishes to 
establish beyond question the fact that there are sufficient 
funds on deposit, the common practice is to have the check 
certified by the cashier of the bank upon which it is drawn. 
It then becomes a certified check. A certified check, then, is 
one on which the word “Good” or its equivalent, has been 
stamped or written, together with the date and signature of 
the cashier or paying teller of the bank thereby certifying 
that the drawer of the check has sufficient funds on deposit 
to pay it and making the bank liable to the holder for its pay¬ 
ment. When the bank certifies a check it immediately sets 
aside so much of the maker's funds on deposit to pay it, as 
a means of self-protection. 

Liability of the Maker of a Check after Certification 

No one in giving a check, whether certified or not, makes 
any representation as to the solvency of the bank, and the 
only case in which the liability of the maker of a certified 
check can arise is in event of the bank’s insolvency. 

Upon certification the bank becomes entitled to, and if 
its business is properly conducted actually does, charge the 
amount of the check to the account of the drawer, thus in 


4io 


CREDIT AS A MEDIUM OF EXCHANGE 


reality apropriating to the payment of the check the necessary 
amount of the money on deposit to the credit of the drawer, 
precisely the same as though the check were paid. In other 
words, as between the bank and the drawer, certification -has 
the same effect as payment, the funds representing the amount 
of the check being just as effectively withdrawn from the 
control of the drawer. 

The question whether this change in the rights and rela¬ 
tions of the parties should discharge the drawer from further 
liability on the check is still in an unsettled state, but the 
weight of opinion is in favor of the conclusion that the drawer 
under such circumstances is discharged. On principle, cer¬ 
tification, instead of creating an additional obligation on the 
check itself, creates an entirely new instrument, superseding 
the check altogether, by reason of which the prior parties to 
the check are wholly discharged. 

It being established that when the holder procures the 
certification of a check the maker thereof is discharged, 
because the maker has lost all control of his funds to the 
amount of the check and the holder has obtained a new 
obligation from the bank to honor the check when pre¬ 
sented for payment, the same reason would seem to apply with 
equal force to the case where the maker himself procures the 
certification before he delivers the check to the payee. The 
payee in such a case takes the check solely on the obligation of 
the bank. 

In other words, a certified check is a substituted obliga¬ 
tion, whereby the maker is discharged. The holder or payee 
impliedly says, “Give me the promise of the bank, and 
I will discharge you,” and the maker says to the bank, “Prom¬ 
ise the payee and I will discharge you.” The check is thereby 
necessarily extinguished and it becomes a promissory note of 
the bank, or, as it has been held in numerous cases, a certified 
check is the same as a certificate of deposit. 1 


iSee VI Har. Law Rev., 138. 



NEGOTIABLE INSTRUMENTS 


411 

State of Authorities 

The law is well settled that if the payee or subsequent 
holder procures the certification, the maker is discharged. But 
it has been held in numerous cases arising in different juris¬ 
dictions, that where the maker himself procured the certifica¬ 
tion, he was not discharged. (Illinois, Colorado, New Jersey, 
Ohio, Louisiana, New York, and Indiana.) The reasoning in 
these cases is not clear, and it is difficult to see wherein the 
courts have been justified in drawing their distinction where the 
payee has procured the certification. 

In order consistently to uphold this distinction, it is neces¬ 
sary to maintain that in one instance a certified check is a new 
instrument, a promise on the part of the bank substituted 
for the check; and that in the other the old obligation, although 
an entirely different instrument after the certification, persists 
with the original liabilities. In other words, “the logical con¬ 
clusion to be drawn from such a distinction is that the legal 
effect of a certification is not the same in all cases, whereas 
it is impossible for the same act to have two different legal 
consequences.’ ’ 

Opposed to those jurisdictions already referred to is the 
decision of the United States Supreme Court, reported in.94 
U. S. 343, wherein the court stated: 

Whether this certification be obtained by the drawer before 
the check is delivered, and is thus made an inducement to the 
payee to receive the same, or whether it is made upon the 
application of the payee for his security, is of no importance. 

Liability of the Bank before Certification 

To the Drawer. There is an implied promise on the part 
of banks to honor all checks and drafts drawn by the depositor 
when presented for payment, provided there are sufficient funds 
on deposit. And the law is well settled that in event a check 
or draft'is wrongfully dishonored by the bank, the depositor 
may maintain an action against the bank for whatever damage 


412 


CREDIT AS A MEDIUM OF EXCHANGE 


he or his business reputation may have suffered as a result 
of it. 

To the Payee. This promise on the part of the bank, 
however, creates no privity between the bank and the party in 
whose favor the check or draft is drawn, and consequently a 
breach of this obligation does not give rise to a right of action 
in behalf of such creditor, unless the check has been certified. 
There are jurisdictions, 2 however, where it has been held that 
the drawing of a check operates as an assignment of the amount 
for which it is drawn, thus creating a direct obligation on the 
part of the bank to the payee, and for the breach of which 
the payee can hold the bank liable. 

Liability of the Bank after Certification 

After certification, however, the obligation of the bank to 
the holder of the check becomes direct and absolute. In a 
New York case involving this question, the court laid down 
this general principle: 

By certification the bank enters into an absolute undertaking 
to pay the check when presented within the Statute of Limita¬ 
tions. The transaction as between the holder of the check and 
the bank is substantially the same in legal effect as though the 
holder-had received payment and had deposited the money with 
' the bank and received a certificate of deposit therefor. 

Post Office Money Order 

A post office money order (Form 23 s ) is an order issued by 
one post office on another directing the payment of the sum 
specified therein to the person designated, or to his order. The 
maximum amount for which a single money order may be 
issued in the United States is $100. The rates range from 3 
cents, when the amount is $2.50 or less, to 30 cents for $100. 
It is a negotiable instrument that is widely used to facilitate 
the transfer of funds, and it performs a function similar to 
checks and bank drafts. 


2 Illinois and Nebraska. 

3From Kester and Koopman, Fundamentals of Accounting, Vol. I. 



NEGOTIABLE INSTRUMENTS 


413 


When a purchaser of merchandise does not carry a bank 
account and desires to send money in payment of a purchase 
to someone at a distance, a money order for the desired amount 
may be purchased at any branch post office and made payable 


21834 


New 


SU. 3. N.T. 


OffKi HWKM* 


31 




United States Postal Money Order 

_ AUG 1 5 1921 


THE POSTMASTER AT 





WILL PAY AMOUNT STATED AfldVE TO OR^ROF PAYEE NAMED IN ATTACHED COUPON OF SAME 

NUMBER. I f ISSUED WITHIN THE CONTINENTAL UNITED STATES. ALASKA EXCEPTED. THE 
POSTMASTER AT ANY MONEY CROER OFFICE IN THE CONTINENTAL 
UNITED STATES. ALASKA EtCEPTEO. WILL PAY IF PRESENTED WITHIN 


TH1&TY DAYS FROM DATE OF ISSUE 


orno* 




POSTMASTER 


RECEIVED PAYMENT 


lUWU MJMMI 


New Rochelle, Sta. 3, N. Y. 
21834 

°"' c * Coupon for Paying Offji 

_ rot to sc octachko bvi^mk^ 


31 



ARS_C_A-_CENTM 

n«uo4 • TO* CENTS 






Remitter • f / 






THIS MONEY ORDER IS NOT OOOO 
FOR MORE THAN LARGEST AMOUNT 
INDICATED ON LEFT-HAND MARGIN 
OF THE ORDER ANO ANY ALTERA¬ 
TION OR ERASURE RENDERS IT VOID 


Form 23. Post Office Money Order. 

to the seller, who upon receipt of it presents it at his post 
office and receives payment. 

Stipulation Providing for Payment of Collection Costs and 
Attorney’s Fees Does Not Affect Negotiability of Instru¬ 
ment 

Article n, section 20 of the Negotiable Instruments Law 
provides that: 

The sum payable is a sum certain within the meaning of this 
Act, although it is to be paid with costs of collection, or an 
attorney’s fee, in case payment shall not be made at maturity. 

Validity of Provision 

There is not a sufficient uniformity among the decisions on 
this question to establish any general rule of law, but the 
weight of authority seems to favor the validity of such 
provision. The decisions on the point may be classified as 
follows : 4 


4 See Credit Men’s Manual of Commercial Laws, p. 207. 


























4H 


CREDIT AS A MEDIUM OF EXCHANGE 


i. Where the instrument specifies no definite amount, 
(a) States holding stipulation valid: 


Alabama 

Missouri 

Arizona 

Montana 

Dakota 

Oklahoma 

Florida 

Oregon 

Idaho 

Pennsylvania 

Illinois 

South Carolina 

Indiana 

Tennessee 

Iowa 

Texas 

Louisiana 

Utah 

Maryland 

Virginia 

Minnesota 

Washington 

Mississippi 

Wisconsin 

(b) States holding stipulation 

invalid: 

Arkansas 

Nebraska 

District of Columbia 

North Carolina 

Kansas 

Ohio 

Kentucky 


Where the instrument specifies 

a definite amount, 

(a) States holding stipulation 

valid: 

Alabama 

Mississippi 

California 

Missouri 

Colorado 

New Mexico 

Dakota 

Oklahoma 

Florida 

South Carolina 

Idaho 

Tennessee 

Illinois 

Texas 

Indiana 

Washington 

Louisiana 

Wisconsin 

Minnesota 


(b) States holding stipulation invalid: 

Arkansas 

Michigan 

District of Columbia 

North Carolina 

Kentucky 

West Virginia 


NEGOTIABLE INSTRUMENTS 


415 

What Law Governs Validity and Enforcement of Provision 

The validity of the provision with regard to costs of collec¬ 
tion is a question of substantive law, and is therefore deter¬ 
mined in accordance with the laws of the state in which the 
obligation was entered into. Such being the case, if the pro¬ 
vision is valid in the state in which the obligation was made, 
it will be recognized as valid in other states, unless it is denied 
such recognition on the ground that such an agreement is 
contrary to public policy. 

The enforcement of such a provision is a question of 
remedy, and therefore determined in accordance with the law 
of the state in which it is sought to enforce the obligation. 
Such being the case, if the provision is valid in the state in 
which the obligation was entered into but invalid in the state 
in which suit is brought, such fees are not recoverable. 

Documents of Title 

Warehouse receipts and bills of lading are not, strictly 
speaking, negotiable instruments, as neither provides for the 
, payment of money, but rather negotiable documents of title 
to goods, susceptible to transfer under quite similar regulations 
whereby title to the goods designated in the instrument is 
transferred. 

Sales by Transfer of Document of Title 

When goods are shipped, a document is issued by the carrier 
which partakes of a twofold nature: (1) it acknowledges 
receipt of the goods described therein, and (2) promises to 
deliver the goods to the proper party and at the place specified 
therein. This document is called a “bill of lading.” 

When goods are stored in a public warehouse, a similar 
document: (1) acknowledging receipt of the goods, and (2) 
agreeing to deliver them to the proper party on demand or at 
some specified future time, is executed by the warehouse 
company. This document is called a “warehouse receipt.” 


4 i6 credit as a medium of exchange 
• 

Documents of this kind are called “documents of title.” 
They represent the goods, and a sale or pledge of the goods can 
be accomplished by a transfer of the document representing the 
goods. 

Negotiable and Non-Negotiable Documents of Title 

Bills of lading and warehouse receipts may be issued in 
either negotiable or non-negotiable form, depending on whether 
delivery is to be made to “the consignee only” or to “the con¬ 
signee or his order.” A non-negotiable bill of lading is called 
a “straight” bill of lading, and a negotiable bill is called an 
“order” bill. The former directs the carrier to deliver the 
goods to some particular person specified in the bill of lading 
and to none other; whereas a negotiable bill of lading directs 
the carrier to deliver the goods to some particular person 
specified in the bill of lading “or order,” meaning, or according 
to the order or subsequent directions of the consignee. 

How Transfer Is Effected 

The transfer of a document of title is effected by a delivery 
of the document, properly indorsed when necessary. Negoti¬ 
able documents of title are made deliverable either “to the 
order” of a certain person, or “to bearer.” If the former, the 
person so specified must indorse the bill; if it provides for 
delivery “to bearer,” such an indorsement is not necessary and 
transfer may be accomplished by mere delivery of the docu¬ 
ment. A non-negotiable document of title can also be trans¬ 
ferred by assignment. 

Effect of Transfer 

Both kinds of documents are transferable to effect a sale 
or transfer of the goods, but there is an important distinction 
made in determining the legal rights resulting from such 
transfer. 

In the first place, the carrier need not assume that a straight 


NEGOTIABLE INSTRUMENTS 


417 

bill of lading has been transferred until he has been notified of 
the transfer, and he may, therefore, deal with the original con¬ 
signee specified in the bill of lading without his production 
of the bill of lading; whereas in the case of a negotiable bill 
of lading it must be assumed that the bill of lading may have 
been transferred and therefore its production must be required 
by the carrier before the goods are delivered. 

Secondly, while both kinds of documents are transferable, 
the transfer of a non-negotiable bill of lading has only the 
effect of a legal assignment of the rights of the transferer, or 
consignee specified in the bill; whereas the transfer of a negoti¬ 
able bill of lading entitles the transferee to all the rights and 
remedies of an innocent purchaser for value of a negotiable 
instrument under the Negotiable Instruments Law. 

The importance and practical effect of this distinction can 
best be illustrated by supposing the following examples: 

1. A ships goods to B and the bill of lading (straight) 
directs delivery to consignee B. 

2. A ships goods to B and the bill of lading (negotiable) 
directs delivery to consignee B “or order.” 

The bill of lading in each instance is sent to B, who in both 
instances indorses it to C, an innocent purchaser of the goods 
for value. The following day B becomes insolvent, and upon 
receipt of this information A immediately exercises his right of 
stoppage in transitu and instructs the carrier to hold the goods. 

In (1), the document being straight, or non-negotiable, C 
by transfer of the document could get no better title or greater 
right to the goods than B. In other words, whatever rights 
A has against B with regard to refusing to deliver the goods, 
he likewise has against C, and as B cannot demand delivery 
of the goods from the carrier because of his insolvency, neither 
can C. 

In (2), however, the document was drawn “to B or order,” 
showing that it was intended to give B the privilege of trans¬ 
ferring the title to the goods by transfer of the bill of lading, 


418 


CREDIT AS A MEDIUM OF EXCHANGE 


and inasmuch as B was solvent at the time he indorsed the 
bill of lading to C, C thereby got a good and independent title 
to the goods and is in a position to demand delivery from the 
carrier, as he now has a greater right to the goods than B 
through whom he derived title. A is left to get what he can by 
sharing with the other general creditors in the insolvent estate 
of B. 

Furthermore, the result would be the same from a legal 
point of view where a negotiable bill of lading is transferred 
to a bona fide purchaser for value after the transferring has 
become insolvent. The principle underlying this rule of law 
is that where a loss must be suffered by one of two innocent 
parties, it should fall on the one who made the loss possible, 
which in such a case would be the creditor who sold the goods 
on credit and made it possible for the purchaser to transfer 
title to the goods by transfer of the negotiable bill of lading. 

It is also well to remember that neither a carrier nor a 
warehouseman warrants that title to the goods is in the deposi¬ 
tor (the goods may consist of stolen property), but merely that 
the goods specified in the document have been received from the 
consignor, and they are therefore under obligation to surrender 
the goods to the rightful owner in event the property was 
stolen—otherwise they would render themselves liable for 
“conversion” of another’s property. 


CHAPTER XXXIV 


NEGOTIATION 

Methods of Negotiation 

Negotiation, or transfer, may be: (i) by indorsement and 
delivery, or (2) by delivery alone, according to the nature of 
the instrument and whether it does or does not require an 
indorsement. 

An instrument is negotiated when it is transferred from one 
person to another in such manner as to constitute the transferee . 
the holder thereof. If the instrument is payable “to bearer,” 
or if the last indorsement is in blank, it may be negotiated by 
delivery, the same as money. If payable “to order,” it is nego¬ 
tiated by the indorsement of the holder on the back of the 
instrument followed by delivery. 

Indorsement consists in writing the name of the indorser 
on the instrument with the intent either to transfer title to same, 
or to strengthen the security of the holder by assuming a con¬ 
tingent liability for its future payment. 1 It is primarily a con¬ 
tract whereby the indorser promises to pay according to the 
tenor of the instrument in event it is dishonored by the maker 
or acceptor when presented for payment, provided he is properly 
notified. An indorser incidentally warrants: 

1. That the instrument is genuine (free from forgery). 

2. That he has a good title to it to transfer. 

3. The contractual capacity of the parties to it. 

4. That he has no knowledge of any fact which would 

impair its validity. 


1 Norton, Bills and Notes. 


419 



CREDIT AS A MEDIUM OF EXCHANGE 


420 

Kinds of Indorsement 

Indorsements may be either special or in blank, and may 
be qualified or unqualified. 

A special indorsement specifies the person to whom, or 
to whose order, the instrument is payable, and the indorsement 
of such indorsee is necessary to the further negotiation of the 
instrument. 

Example : Pay to A B or order. 

This could not be transferred or negotiated without the 
indorsement of A B. 

A blank indorsement specifies no indorsee. The indorser 
simply writes his name on the back of the instrument, and it 
thereupon becomes payable to bearer and may be negotiated or 
transferred by delivery. The holder may convert a blank 
indorsement into a special indorsement by writing over the 
signature of the indorser in blank any contract consistent with 
the character of the indorsement. 

Such unqualified or unrestricted indorsements place no 
restriction upon the further negotiation of the instrument. 

A qualified indorsement simply passes title to the instru¬ 
ment without rendering the indorser liable upon the paper. 
Such an indorsement constitutes the indorser a mere assignor, 
and the holder a mere assignee of the title to the instrument. 

It may be made by writing above the indorser’s name the 
words : “Without recourse,” or other words of similar import. 
Such an indorsement does not impair the further negotiability 
of the instrument; it simply exempts the indorser from liability 
upon it. 

Example: Without recourse 

Malcolm Kemper & Co. 

A restrictive indorsement is one which makes the indorsee 
the agent of the indorser for some particular purpose, usually 
for collection or for deposit. A restrictive indorsement con¬ 
fers upon the indorsee the right: 


NEGOTIATION 


421 


1. To receive payment of the instrument. 

2. To bring any action thereon that the indorser could 

bring. 

3. To transfer his rights as such indorsee where the form 

of the indorsement authorizes him to do so. 

But all subsequent indorsees acquire only the title of the 
first indorsee under the restrictive indorsement. Such an in¬ 
dorsement also serves as notice that the holder does not own 
the paper, and therefore practically prohibits further negotia¬ 
tion except for collection purposes. 

Example : Pay to A B for collection 

Malcolm Kemper & Co. 


Liability of Indorser 

The legal liability of the indorser of a negotiable instru¬ 
ment is of a twofold nature: (1) he undertakes to pay the 
instrument if it is dishonored by the payee at maturity, and 
due notice thereof given the indorser (a qualified indorser, 
however, does not assume any such obligation to pay) ; and 
(2) he warrants: 

(a) That the instrument is genuine and in all respects 

what it purports to be. 

(b) That he has a good title to it. 

(c) That all prior parties had legal capacity to enter into 

such a contract. 

(d) That he has no knowledge of any fact which would 

impair the validity of the instrument or render it 

valueless. 

When a person places his indorsement on an instrument 
negotiable by delivery, he thereby incurs all the liabilities of an 
indorser. 

Rights of Holder 

The last transferee or indorsee is the holder. He may be a 
'‘holder in due course,” or “not a holder in due course,” and 


422 


CREDIT AS A MEDIUM OF EXCHANGE 


his legal rights under the instrument are largely determined 
by his position in this respect. 

Meaning of Phrase “Holder in Due Course.” A 
holder in due course has been defined as one who takes com¬ 
pleted and regular paper before maturity, in good faith, for 
value, and without notice of any defects or defenses. Such a 
holder is often called a “bona fide holder for value without 
notice,” but the phrase “holder in due course” is the one that 
is used in the Negotiable Instruments Law to signify an in¬ 
nocent holder for value, or one who has taken the instrument 
without knowledge of anything unusual in connection with it, 
and has given a valuable consideration for it. 

What Constitutes a Holder in Due Course. In order 
to be a holder in due course a transferee must have taken the 
instrument under the following conditions: 

1. The instrument must be complete upon its face. 

2. He must have become the holder of it before it became 

overdue, and without notice that it had been previously 
dishonored, if such were so. 

3. The holder must have taken it in good faith and for 

value. 

4. At the time it was negotiated to him he must have had 

no notice of any infirmity in the instrument or defect 
in the title of the person negotiating it. 

5. A holder who derives title through a holder in due course 

is himself a holder in due course, even though he 
does not comply with the above requirements. 

Rights of Holder in Due Course. The following rules 
govern the legal rights of a holder in due course: 

1. A holder in due course holds the instrument free from 
all personal defenses (fraud, duress, illegality, lack of con¬ 
sideration, release of maker, etc.) and may enforce payment 
for the full amount specified against all parties liable upon it; 
but he does not hold it free from the absolute defenses 
(forgery, material alteration, infancy, etc.). 


NEGOTIATION 


423 


2. Every holder of a negotiable instrument is presumed 
to be a holder in due course. But when fraud, illegality, or 
a defective title has been set up as a defense, the burden of 
proof rests on the holder to prove that he purchased the instru¬ 
ment for value and without notice of any such irregularity. 

Effect of Irregular Transfer 

If the holder of a negotiable instrument is not a holder in 
due course, and sues thereon for payment, he may be con¬ 
fronted with all the defenses that may be interposed in a suit 
between the original parties as to why the instrument should 
not be paid. 

Defenses 

This brings up the subject of defenses which may be set 
up by a party to a negotiable instrument. They are generally 
classified into two groups: (1) real defenses, and (2) per¬ 
sonal defenses, depending on whether the defense is attached 
to the instrument itself, or has grown out of the agreement 
of the parties to the instrument. 

Real or absolute defenses are those which render the in¬ 
strument unenforcible because there is no contract to enforce, 
the instrument being void in its inception, such as forgery, 
infancy, illegality, lack of mental capacity, and material altera¬ 
tion. 

Personal or equitable defenses do not invalidate the instru¬ 
ment but question the rights of the parties growing out of the 
agreement, such as fraud, duress, want of consideration, re¬ 
lease, and illegality (when not made a real defense by statute). 

Whether or not payment may be refused on any of these 
grounds depends on whether or not the holder acquired legal 
title to it without notice of any defects or irregularities, and 
for value. If so, all equitable defenses are cut off and do not 
avail against a “purchaser for value and without notice.” 

In the case of a check it should be promptly presented for 


424 


CREDIT AS A MEDIUM OF EXCHANGE 


payment or deposited for collection. If it is not, the drawer 
may be discharged from liability to the extent of the loss, 
which may be directly attributed to the delay. A local check 
should be presented for payment before the close of banking 
hours on the day following the date of its issue. 

Overdue Paper 

After maturity, negotiable instruments may be transferred 
by delivery or indorsement, but in such instances the indorsee 
takes the same, and only the same, interest that his indorser 
had; in other words, he takes subject to whatever defenses 
might have been set up against the indorser. 

Presentment 

The maker of a note, or acceptor of a draft, is liable with¬ 
out presentment for payment, but if the indorser is to be held 
there must be due presentment upon the maker for payment, 
except in the case of demand paper which must be presented 
within a reasonable time. 

Time of Presentment. If the instrument is payable at a 
fixed time, presentment must be made on the day fixed. If 
the due day falls on Saturday, the Negotiable Instruments 
Law provides that the instrument is to be presented the fol¬ 
lowing Monday. If the instrument is payable “on demand,” 
presentment must be made within a reasonable time after its 
issue. 

Presentment must be made at a reasonable hour on a busi¬ 
ness day, which means within the usual hours of business. 

Place of Presentment. Where a particular place of 
payment is specified in the instrument, presentation must be 
made at that place. Where no particular place is specified, the 
place of business, or residence, of the maker is understood or 
implied. 

Mode of Presentment. To constitute a legal present¬ 
ment the instrument must be exhibited to the person from 


NEGOTIATION 


4^5 

whom payment is demanded, and when it is paid, the instru¬ 
ment must be delivered up to the party paying it. 

Notice of Dishonor 

Necessity of Notice. The second condition on which 
the indorser assumes liability for payment is that due notice 
shall be given him that the instrument has been dishonored 
when presented for payment, and any indorser to whom such 
notice is not given is discharged as having been deprived of 
the opportunity to avail himself of whatever rights he may 
have had for immediate self-protection. 

Augusta, Ga., .. . .Oct. i 5 . 192— 

Sir— 

Take Notice, that a . note . 

. made .by. Karl A. Griffith . 

For. $700 . 

Dated . July 27, 192 — . 

Payable. three months .after date, . 

at. the Merchants .National Bank, of Augusta, and 

endorsed by you, was this day Protested for non-payment and that the 
holders look to you for the payment thereof, payment having been de¬ 
manded and refused. 

Yours respectfully, 

. Frank D. Wickham . 

Notary Public 

To ... Oliver C. Edwards. .. 

Form 24. Notice of Dishonor 

/ 

Form of Notice. The notice (Form 24) may be written 
or oral, and it is sufficient if it identifies the instrument and 
indicates that it has been dishonored for non-payment. It may 
be delivered personally, or sent by mail. It may be given to 
the party himself or to some authorized agent. 

Time of Notice. Where both parties reside in the same 
place, personal notice must be given at the place of business of 
the person entitled to receive notice before the close of business 
hours on the following day. If given at his residence, it must 
be given before the usual hours of rest on the following day. 




















426 


CREDIT AS A MEDIUM OF EXCHANGE 


If sent by mail, it must be deposited in the post office in suf¬ 
ficient time for delivery within business hours on the following 
day. 

If the parties reside in different places, the notice should 
be deposited in the post office in time to go out by mail on the 
following day. 

Where the holder gives notice to the indorser, the indorser 
has, after receipt of such notice, the same time for giving 
notice to a prior or antecedent indorser. 

Place of Notice. If the indorser has added an address 
to his signature, notice should be sent there. Otherwise, 
notice must be sent either to the post office where he is accus¬ 
tomed to receive his mail, or to the post office nearest to his 
place of residence. If he lives in one place and has his place 
of business in another, notice may be sent to either place. 

If notice of the dishonor of the instrument is received 
within the prescribed time, it will be sufficient even though not 
given in accordance with the above requirements. Delay in 
giving notice is excused when due to circumstances shown to 
have been beyond the control of the holder. 

Protest 

Protest consists of a formal declaration by a notary in 
behalf of the holder that the instrument has been presented for 
payment, payment refused, and the instrument thereupon dis¬ 
honored, followed by a formal protest that any loss resulting 
therefrom shall be borne by the indorsers and not the holder. 
In event a notary is not available to make such protest, it may 
be made by any reputable citizen in the presence of two or 
more witnesses. 

The formality of protest is not necessary, except in the 
case of foreign bills, and the fact of dishonor may be proved 
by the oral testimony of the party who made the presentment; 
but as a matter of formality and convenience in proving the 
dishonor, it is usual and customary to protest all negotiable 


NEGOTIATION 


427 


instruments. In fact, if it is desired to avoid the expense of 
protest on instruments payable at a bank, it is necessary to 
attach notice of “No protest” to the instrument. 

The notary also gives the necessary notice of dishonor to 
the indorsers, but this may be done by the holder or his 

Certificate of Protest 
United States of America 

State of Georgia 

Be it Known, that on the .... 15th _day of_ October .... in the 

year of our Lord, One Thousand Nine hundred .. . .twenty - .. .., at the 

request of Merchants National Bank of Augusta, Georgia, I, Frank D. 
Wickham, Notary Public duly Commissioned and Sworn, dwelling in the 
City of Augusta, and State aforesaid, did present the original .... note .... 
of .... Karl A . Griffith .... for .... Seven hundred .... Dollars, hereunto 
annexed, at the ....Merchants Natoinal Bank — Augusta.... where the 
same is payable, and demanded .... payment .... which was refused. 

Whereupon, I, the said Notary, at the request of aforesaid, did 
protest and by these presents do public and solemnly protest, as well against 
the Maker and Endorser of the said .... note .... as against all others 
whom it doth or may concern, for exchange or re-exchange, and all costs, 
charges, damages and interest, already incurred, and to be incurred for 
w^nt of .... payment .... of the same. 

And I, the said Notary, do hereby certify, that on the same day and 
year above written, due notices of the foregoing Protest were put into, the 
Post Office at Augusta, postage paid, or served as follows: 

Notice.. . .Robert Blair .directed. Savannah, Ga . 

do. Francis M. Bowles . . . .do ... .9 Kemper St., Elberton, Ga.. .. 

do. Frank Blaine .do. 77 Green St., Augusta, Ga . 

Each of the above named places being the reputed place of residence 
of the person to whom the notice was directed. 

In Witness Whereof, I have hereunto subscribed my name and 
affixed my Seal of Office. 

. Frank D. Wickham . 

Notary Public. 

Notary’sI 
Seal j 

Form 25. Certificate of Protest 

authorized agent. The protest fees which are fixed by statute 
are added to the amount to be paid by any party liable on the 
instrument. 















428 CREDIT AS A MEDIUM OF EXCHANGE 

Procedure 

When the instrument has been dishonored for non-payment, 
the notary prepares a certificate (Form 25) under his hand 
and seal setting forth : 

1. The time and place of presentment. 

2. The manner in which the presentment was made. 

3. The request for payment and the refusal given. 

4. The cause or reason for protesting the instrument. 

This certificate, or a copy of it, is then annexed to the 
instrument returned to the holder as evidence of the present¬ 
ment, demand, and dishonor, and a copy sent to each indorser. 

Bad Check Legislation 

In keeping with the general campaign of the National 
Association of Credit Men for uniform state legislation per¬ 
taining to various legal aspects of credit work, a movement 
has for some time past been under way to obtain for merchants 
and creditors adequate protection from the pernicious practice 
of issuing and negotiating worthless checks—a source of con¬ 
siderable annoyance to a credit man, because the return of 
every dishonored check necessitates the reopening of the 
account and requires further time and attention on the part of 
the collection department to effect a settlement. 

To this end laws have been enacted in 45 states (the three 
exceptions being Delaware, New Hampshire, and New Mex¬ 
ico), making it a crime and providing a penalty for the drawing 
of checks with intent to defraud without sufficient funds on 
deposit at the time the check is placed in circulation. 

The New York legislature passed such a law in April, 1918. 
It provides: 

§i292-a. Obtaining money by fraudulent check, draft or order; 
how punished. Any person who, with intent to defraud, shall 
make or draw or utter or deliver any check, draft or order 
for the payment of money upon any bank or other depositary, 


NEGOTIATION 


429 


knowing at the time of such making, drawing, uttering or 
delivering that the maker or drawer has not sufficient funds in 
or credit with such bank or other depositary for the payment 
of such check, although no express representation is made in 
reference thereto, shall be guilty of attempted larceny, and if 
money or property is obtained from another thereby is guilty 
of larceny and punishable accordingly. 

In any prosecution under this section as against the maker 
or drawer thereof, the making, drawing, uttering or delivering 
of a check, draft or order, payment of which is refused by the 
drawee because of lack of funds or credit, shall be prima 
facie evidence of intent to defraud and of knowledge of insuffi¬ 
cient funds in or credit with such bank or other depositary, unless 
such maker or drawer shall have paid the drawee thereof the 
amount due thereon, together with interest and protest fees, 
within ten days after receiving notice that such check, draft or 
order has not been paid by the drawee. 

The word “credit,” as used herein, shall be construed to 
mean an arrangement or understanding with the bank or deposi¬ 
tary for the payment of such check, draft or order. 

This law, and others of a similar nature, are primarily laws 
or rules of evidence, the effect of which is to shift the burden 
of going forward with the evidence from the prosecution to 
the defendant. 

To give a bad check with intent to defraud in exchange for 
goods has long been a crime, but in order to prosecute suc¬ 
cessfully such a case it was necessary for the prosecution to 
prove the intent to defraud, and the knowledge on the part of 
the drawer of the check that he had not sufficient funds on 
deposit to cover the amount for which it was drawn, d o 
prove such an intent requires that one prove what was in 
another’s mind at the time the act was committed, which is 
such a difficult and almost hopeless task that it has been possible 
to give bad checks with impunity. 

Notice of Non-Payment of Check 

Under such a “bad,” or “no-good” check law, as it is some¬ 
times called, if a check has been returned unpaid, owing 


430 


CREDIT AS A MEDIUM OF EXCHANGE 


to an insufficiency of funds on deposit to meet it, the holder 
may give notice to the maker of the non-payment together with 
the reason therefor, and if the maker does not deposit with the 
bank within io days after receiving such notice the amount 
due, his failure to do so constitutes prima facie evidence of his 
intent to defraud, and of knowledge on his part that he did 
not have sufficient funds on deposit at the bank. This simply 
means that whereas the burden of proving the commission of 
the crime still rests upon the prosecution, the burden of going 
forward with the evidence has shifted over onto the shoulders 
of the defendant. 

This phase of the law has been criticized on the ground 
that it permits the individual defrauded to condone the crime 
upon payment of the sum which he has lost. But, as has been 
pointed out, this criticism is not sound, for the crime exists 
even though the money be repaid. The effect of payment of 
the money is only to restore to the maker of the check the 
common law presumption of innocence, and place on the state 
the burden of proving the intent to defraud and a knowledge 
of having insufficient funds on deposit. 

While the statute is silent on the question as to what con¬ 
stitutes proper notice, it would not be prudent for a creditor to 
endeavor to prosecute a case under the statute unless he is able 
to prove the giving of proper notice. As a matter of precaution 
in such instances, the notice should be in writing and should be 
either handed personally to the maker, or if mailed, the letter 
should be registered and a return receipt requested. 

Four General Situations 

A question which logically arises is as to whether this law 
applies only to instances where the check was given within the 
state, on a local bank, and for goods sold within the state, or 
likewise applies to cases wherein the debtor resided without 
the state, and the check was drawn on the bank of another 
state, or given in payment for goods sold without the state. 


NEGOTIATION 


431 


In this connection, there are four general situations with which 
to deal: 

1. Where a resident or non-resident delivers a check within 

the state on a bank located within the state. 

2. Where a resident or non-resident delivers a check within 

the state on a bank located without the state. 

3. Where a resident or non-resident delivers a check out¬ 

side of the state on a bank located within the state. 

4. Where a resident or non-resident delivers a check out¬ 

side of the state on a bank located out of the state. 

In the first and second instances the law applies irrespective 
of where the check was drawn. 

In the third and fourth instances the law does not apply 
unless the check was drawn within the state, in which cases the 
courts may hold that it does apply. 

In other words, under such a statute, the fact that the bank 
upon which the check was drawn was located in another state 
would be immaterial in event the check was either drawn or 
delivered within the state, because not only does the law provide 
that the delivery of a check within the state with fraudulent 
intent is a crime, but also that the drawing of a check within 
the state with like intent is likewise a crime. 

Check Given after Sale and Delivery of Merchandise 

The question has also been raised as to whether the law 
applies to a check given in payment for merchandise sold and 
delivered previous to the giving of the check. Opinion on this 
point is divided. Those who give a negative opinion contend 
that as nothing of value was parted with in exchange for the 
check, no injury has resulted to the person receiving the check, 
and that, consequently, no crime has been committed. Until 
the courts pass on this question it must remain a mooted one. 2 

In some states, no such notice of dishonor to the drawer 
is required. For example, the “no-good” check law of Ohio, 
enacted in April, 1919, provides: 


2 See bulletin New York Credit Men’s Association for December, 1919. 



43 2 


CREDIT AS A MEDIUM OF EXCHANGE 


Any person who, with intent to defraud, shall make or draw 
or utter or deliver any check, draft or order for the payment of 
money upon any bank or other depository, who, at the time 
thereof, has insufficient funds or credit with such bank or deposi¬ 
tory, shall be guilty of a felony, and upon conviction thereof 
shall be fined not less than fifty dollars and not more than two 
hundred dollars, or imprisoned in the Ohio State Penitentiary 
for not less than one year nor more than three years or both. 

As against the maker or drawer thereof, the making, drawing, 
uttering or delivering of a check, draft or order, payment of 
which is refused by the drawee, shall be prima facie evidence of 
intent to defraud, and knowledge of insufficient funds in, or 
credit with, such bank or other depository. The word “credit” 
as used herein shall be construed to mean any contract or agree- 
ment with the bank or depository for the payment of such check, 
draft or order, when presented. 

Proving Criminal Intent 

The same difficulty is experienced in the enforcement of 
such a law as is encountered in other cases involving the 
element of fraud, in that before any conviction can be obtained 
under the statute it is necessary to prove the existence of the 
necessary criminal intent at the time the act complained of was 
committed. 

In other words, given a case wherein a check was issued 
by a merchant when there were insufficient funds on deposit in 
the bank to cover the amount for which it was drawn, the 
proof of these facts would, by virtue of the statute, constitute 
prima facie evidence of an intent to defraud, but the incidental 
presumption that the check was drawn with knowledge of an 
insufficiency of funds on deposit could be rebutted by a direct 
denial of any such knowledge by the drawer of the check, under 
oath. 

It is for this reason that the number of convictions under 
these statutes has been so surprisingly small, and that the 
statute has failed to afford mercantile creditors the degree of 
protection from this abuse that was anticipated of it. 
protection from this abuse which was anticipated would result 
from it. 


CHAPTER XXXV 


THE TRADE ACCEPTANCE 

Use Advocated by Federal Reserve Board 

It is in anticipation of the time when trade acceptances will 
play a more important part in commerce than they do today 
that this subject is taken up at length, for while its use has so 
far been very limited among the merchants of the United 
States, the trade acceptance has for many years been in as 
general use throughout Europe as bills of exchange, and it is 
a medium of exchange with which every credit man should be 
familiar. 

The Federal Reserve Board, through an extensive investi¬ 
gation, determined the fact that an enormous charge was being 
laid on the business of this country by the open account. 
Billions of dollars were being represented by mere pen-scratches 
in ledgers, non-available, rigid, frozen assets. Financial facilities 
were unused, credit and capital alike were being wasted as in no 
other civilized country. Banks, the reservoirs of the wealth of 
the nation, were being used not to finance business in its daily 
course, but as a last resource. The average seller of goods 
financed his own transactions, calling on the banks only in 
emergencies. And so the banks were failing to give to American 
business that service for which they were primarily organized, 
and through no fault of their own. 

Determined to find the means to link together business and 
banking, making each dependent on the other, each supporting 
the other, each responsive to the need of the other, the Federal 
Reserve Board acting under and interpreting the spirit of the 
Federal Reserve Act, selected that class of paper which truly 
represents the business transactions of the country, the purchase 
and sale of goods, as being the medium to establish the intimate 
relationship necessary. 


433 


434 


CREDIT AS A MEDIUM OF EXCHANGE 


And then, to make that link as secure as possible, offering 
the least chance of loss to either party, the Federal Reserve 
Board laid down certain requirements to distinguish the trade 
acceptance from any other commercial paper. The first and 
most important rule is that the acceptance must bear on its face 
the statement that the obligation arises out of the sale and pur¬ 
chase of goods; the second, that the acceptance be a clear, definite 
order to pay, free from any qualifying conditions; the third, that 
the acceptance be accepted in writing across the face of the 
instrument. 

Such an instrument, bearing the names of both a seller and 
buyer of known credit standing, representing goods intended 
for resale, and standing for a current transaction is truly the 
highest form of commercial paper and as such has been granted 
a preferential rediscount rate by Federal Reserve Banks . 1 

Trade Acceptance Defined 

The only difiference between a commercial draft and a trade 
acceptance (Form 26 2 ) is that the latter states on the face of it: 



“The obligation of the acceptor hereof arises out of the pur¬ 
chase of goods from the drawer as per invoice of.”; 

and upon acceptance it likewise becomes a promise to pay 
according to the tenor of the instrument. Consequently, the 
trade acceptance is a negotiable instrument and subject to the 
provisions of the Negotiable Instruments Law. 


1 Credit Men’s Manual of Commercial Laws, p. 29 . 

2 From Koopman and Kester, Fundamentals of Accounting, Vol. I. 



















THE TRADE ACCEPTANCE 


435 


Its Function 

What is the purpose and effect of showing on the face of 
the instrument the basis of the obligation? The reason for it 
is to indicate that the obligation is not based on a loan of 
money or given in settlement of a past-due account. It 
increases the value of the instrument as a live asset, and in no 
way reflects on the buyer’s credit standing. While the instru¬ 
ment is technically a draft, it is practically no more than a 
negotiable receipt and a promise to pay for merchandise 
purchased. 

The theory is that the draft would be drawn for the gross 
amount of the invoice payable in 30, 60, or 90 days, according 
to the terms of sale, and sent to the buyer with a copy of the 
invoice. If the buyer intended to pay within the discount 
period, he would merely destroy the draft. If, on the other 
hand, he did not intend to take advantage of the cash discount 
allowed, he would write “Accepted,” together with the date and 
signature across the face of it, and return it to the seller, 
thereby constituting a trade acceptance. While there is no 
reason why a trade acceptance cannot be made to run for any 
length of time, under the rulings of the Federal Reserve Board 
only such trade acceptances as have a maturity of not more 
than 90 days from date of presentation at a federal reserve 
bank are eligible for rediscount. 

The Use of the Acceptance 

In order to obtain a clear conception as to the manner in 
which the trade acceptance is used, let us suppose that A in 
Cincinnati, sells B in Boston, a bill of goods amounting to 
$3,000, terms 2 per cent in 10 days, 60 days net. Under the 
open-account system, unless B discounts his bill within 10 days, 
the full amount of $3,000 will remain open on A’s books for 
60 days, and while a good asset (assuming the buyer good for 
the amount), it will be for the next 60 days practically a dead 
asset in the sense that A will have to wait that long for his 


436 


CREDIT AS A MEDIUM OF EXCHANGE 


money. Furthermore, it is quite evident that it would not take 
a large number of such outstanding accounts to tie up a con¬ 
siderable portion of A’s capital in accounts receivable, and it is 
easily conceivable that A may, and probably will, be forced to 
borrow money from the bank on his receivables, pending 
maturity of such open accounts. In other words, under such a 
system, the seller is practically compelled to serve as banker for 
his customers, and in event his capital proves insufficient for 
the purpose, it is necessary for him to seek assistance from 
the banks, frequently by discounting his receivables at an 
exorbitant rate of discount. 

Now let us suppose that attached to the invoice covering the 
shipment sent B was a trade acceptance drawn for 60 days, to 
be signed by B and returned, in event he does not intend to 
take discount. Upon its receipt A is placed in a position to 
close the trade on his books immediately and to discount the 
acceptance at his bank at an established rate, without having 
to wait 60 days for his money. 

Advantages and Disadvantages 

The principal grounds on which its general adoption is 
urged are: (i) the advantages derived from the substitution 
of time drafts for open book accounts, and (2) that of pro¬ 
viding better borrowing facilities in negotiating loans from the 
banks. And it is more as a matter of information than with a 
view to championing the virtues of the cause, that the more 
important features involved in its adoption as affecting all 
three parties concerned (seller, buyer, and bank) are given: 

To the Seller 

Advantages. That there is a considerable advantage to 
the seller in its general adoption no one can deny, because: 

1. It enables him to close his ledger account on receipt of 

the acceptance. 

2. By admitting the amount to be correct, the buyer is 


THE TRADE ACCEPTANCE 


437 


precluded from setting up any of those petty griev¬ 
ances and controversies to which a seller is subject. 

3. It places him in a better position to negotiate loans, for 

the holder of an acceptance can sell an asset instead 
of incurring a debt when funds are desired from the 
bank. 

4. When discounting trade acceptances seller will not be 

obliged to give the banks such a wide margin of safety 
in quick assets as would be required in the assignment 
of his open accounts. 

5. It will enable him to calculate his monthly income with 

greater accuracy and certainty. 

6. It amounts to a proof of claim in itself, once the signa¬ 

ture has been proved. 

Disadvantages. On the other hand, its general adoption 
is not entirely free from objectionable features from the point 
of view of the seller because: 

1. Tendency would be to convert cash discount customers 

into acceptance buyers and thereby lengthen the time 
of credit. 

2. Fact that buyer will often have to pay for goods before 

they are received will tend to influence purchasers to 
trade with the more responsible houses, and conse¬ 
quently crowd out the “little fellow.’’ 

3. Before discounting a trade acceptance at his bank the 

merchant must indorse it. Consequently, the gen¬ 
eral adoption of the trade acceptance will mean that 
the merchant will become an indorser for all of his 
customers and therefore contingently liable to the 
extent of their purchases. 

To the Buyer 

Advantages. Some of the advantages that would accrue 
to the buyer from its general adoption are: 

1. By giving a negotiable certificate of his indebtedness 
to the seller, the buyer shows his good faith, and by 
meeting his obligation promptly improves his credit. 


43 § 


CREDIT AS A MEDIUM OF EXCHANGE 


2. The fact that the buyer will wish to avoid putting out 

more paper than he can meet at maturity will tend to 
make him a more careful and conservative buyer, with 
less likelihood of his overloading with unsalable mer¬ 
chandise. 

3. The time buyer will be doing his part to do away with 

the tremendous advantage now enjoyed by those who 
discount their bills and thereby be enabled to com¬ 
pete with his competitors on a more nearly equal 
basis. (This is, of course, based on the assumption 
that cash discount will eventually be eliminated en¬ 
tirely by the trade acceptance.) 

4. It would also tend to make the buyer a better collector, 

because the fact that he must meet his obligations 
promptly will require him to insist upon prompt pay¬ 
ment from his own customers. 

Disadvantages. Perhaps the most objectionable features 
incidental to its general adoption from the point of view of the 
buyer are: 

1. By accepting, he admits the seller’s claim is correct, 

and is thereby cut off from later setting up any 
defense or counterclaim in mitigation of payment. 

2. Necessitates paying for goods before they are received, 

a practice which is objectionable to many mer¬ 
chants. 

Favored by Banks 

While we are of course primarily interested in the relations 
existing between buyer and seller, still, when we consider the 
extent to which merchants are dependent upon commercial 
banks in the operation and development of their business, the 
banking interests should certainly receive serious consideration. 
Suffice it to say, however, that a general adoption of the trade 
acceptance is strongly advocated by the bankers and for reasons 
readily apparent, for in negotiating commercial loans, they 
would receive as security; 


THE TRADE ACCEPTANCE 


439 


1. Tangible evidence of the receivable submitted; 

2. Double security instead of single-name paper (long re¬ 

garded undesirable by the banks for rediscount) ; and 
finally, 

3. We have their assurance that its general adoption would 

result in placing the banking system of the United 
States not only on a more scientific, but a safer and 
more serviceable basis. 

Objections and Difficulties to be Overcome 

Every deviation of importance that has been made from 
established custom or usage in the business world has met with 
a certain amount of opposition as a sort of challenge to its 
right to survive. The trade acceptance constitutes no excep¬ 
tion. It is also true that in all such controversies it is a natural 
tendency for its exponents to overstate its advantages, and like¬ 
wise for its opponents to magnify the objectionable features 
and difficulties to be overcome. In the case of the trade 
acceptance, some of the objections raised, however, unques¬ 
tionably present real obstacles which must be overcome before 
its general adoption can be brought about. Such are the 
following: 

1. Reluctance on part of buyers to issue negotiable paper 

for something which they have not received. 

2. Fear that the paper will fall into the hands of remorse¬ 

less collectors. 

3. Reluctance on the part of large houses to convert their 

“discounters” into time buyers. 

4. Tendency to draw buyers to the big houses of un¬ 

questioned responsibility and thereby squeeze out the 
“little fellow.” 

5. Large credit limits are often based on bills being dis¬ 

counted. Acceptances will require larger lines and 
therefore involve greater risks. 

6. Hesitancy on part of wholesalers and manufacturers to 

depart from old system of open book accounts. 













PART VII 


INSOLVENCY PROCEEDINGS 




CHAPTER XXXVI 


THE THEORY OF INSOLVENCY LEGISLATION 

Need of Insolvency Legislation 

The theory or principle of justice underlying all insolvency 
legislation is that so long as a merchant remains solvent he 
is doing business on his own money and may do with it as he 
wills, but the moment he becomes insolvent he ceases to be 
doing business on his own money—he has spent his own—and 
is beginning to do business upon his creditor’s money. It 
therefore follows that the remaining assets in the debtor’s 
hands are, in part at least, the property of his creditors for 
whose benefit he thereafter holds them. This is, without 
question, the theory upon which the law has sought to protect 
creditors through restrictions (insolvency legislation) which 
have been placed upon the commercial liberty of the insolvent 
debtor. 

Good laws on this subject are not only important but neces¬ 
sary for the preservation of pecuniary integrity and security of 
the economic basis of trading—the extent to which one can 
depend on the engagements or obligations of another—and 
whatever legislation tends to reduce the premium placed on a 
strict observance of the fundamental principles underlying com¬ 
mercial integrity will necessarily have a corresponding effect 
on the confidence and safety with which business is transacted. 
On this subject one writer has said: 

The statistics of bankruptcy prove the fact that a large part 
of all insolvencies arise from notorious misconduct; the proceed¬ 
ings of the insolvency and bankruptcy courts will prove it. 
Excessive and unjustifiable overtrading, or most absurd specula¬ 
tion in commodities, merely because the poor speculator “thought 

443 


444 


INSOLVENCY PROCEEDINGS 


they would go up,” but why he thought so, he cannot tell;—in 
things with which he is altogether unacquainted, wild and 
absurd investments, these are among the most innocent causes 
of bankruptcy. 

To have been trusted with money or money’s worth, and 
to have lost or spent it, is prima facie evidence of something 
wrong, and it is not for the creditor to prove, which he cannot 
do in one case out of ten, that there has been criminality, but 
for the debtor to rebut the presumption, by laying open the 
whole state of his affairs and showing either that there has been 
no misconduct, or that the misconduct has been of an excusable 
kind. If he fail in this, he ought never to be dismissed without 
a punishment proportioned to the degree of blame which seems 
justly imputable to him; which punishment, however, might 
be shortened or mitigated in proportion as he appeared likely 
to exert himself in repairing the injury done. 

Legal Distinction between Insolvency and Bankruptcy 

Commercial insolvency and bankruptcy are not synony¬ 
mous. A merchant is considered insolvent, from a commercial 
standpoint, when he is no longer able to pay his debts as they 
fall due in the ordinary course of business, because of the 
difficulty and delay incidental to converting his assets into cash. 
Whereas insolvency is defined in the Federal Bankruptcy Act 
as follows: 

A person shall be deemed insolvent within the provisions of 
this act whenever the aggregate of his property, exclusive of any 
property which he may have conveyed, transferred, concealed, 
or removed, or permitted to be concealed or removed, with 
intent to defraud, hinder or delay his creditors, shall not, at a 
fair valuation, be sufficient in amount to pay his debts. 

It therefore follows that it is entirely possible for an insol¬ 
vent concern to continue in business indefinitely, if it can 
manage in some manner (usually borrowed money) to meet 
its obligations as they fall due, and remain immune from 
bankruptcy proceedings. In other words, a concern may be 
insolvent but not bankrupt, whereas to be bankrupt it must 


THEORY OF INSOLVENCY LEGISLATION 


445 


necessarily be insolvent. It is not, therefore, technically correct 
to apply the term bankrupt to one who is merely insolvent. 

It is also interesting to note in this connection that statistics 
extending over a period of five years show that 60 per cent of 
the business failures were due either to: (i) incompetence, 
such as bad management, either in making an unwise selection 
of stock in buying, inefficient salesmanship, or an inaccurate 
accounting system; or (2) lack of capital, either insufficient in 
the beginning, failure to keep a sufficient amount of it in liquid 
assets, or an injudicious deflection of funds for the payment of 
interest and dividends. 

Means of Relief Afforded an Insolvent Debtor 

Once insolvent a debtor can do but one of five things: 

1. Effect an adjustment with his creditors. 

2. Make an assignment of all his assets, a process whereby 

his assets are transferred to his creditors. 

3. Apply for a receiver. 

4. Go into bankruptcy, by filing a statement of his assets 

and liabilities with the referee in bankruptcy and 
requesting to be declared a bankrupt. 

5. Wait until his creditors force him into bankruptcy by 

proving he has committed an act of bankruptcy while 
insolvent. 


CRAPTER XXXVII 

ADJUSTMENTS 

Importance of Full and Correct Information 

Bearing in mind that what the insolvent debtor desires is 
a release or discharge from his debts, a formal release from 
each and every one of his creditors would be as effective as a 
decree of the court, in so f,ar as any future liability is concerned. 

Such a release may be brought about in any one of several 
ways, and before a credit man is in a position to make an 
intelligent decision as to the most advisable course to pursue 
in protecting his interests, he must obtain all the information 
he can concerning the business of the debtor. The reason for 
this is that if full information shows that there is some 
justifiable explanation or reason for the embarrassed condition 
of the debtor, and that the nature of the difficulty is of a tem¬ 
porary character, there is no great cause for alarm, and under 
such circumstances a great mistake would be made and a great 
injustice done the debtor if drastic measures were immediately 
resorted to. On the other hand, if such information shows the 
business to be in a precarious condition and the debtor heavily 
involved, steps of a more radical nature must be taken properly 
to safeguard your interests and curtail any further loss. In 
other words, the line of approach must naturally and necessarily 
be largely determined by the existing circumstances which are 
never precisely the same in any two cases. Such an investiga¬ 
tion, of course, may be most satisfactorily accomplished by 
having a personal conference with the debtor at his place of 
business, and where his business records are available, for once 
a debtor admits his insolvency, his books are subject to inspec- 

446 


ADJUSTMENTS 


447 


tion by the creditors. In event, however, that the credit man 
is unable to give the matter his personal attention (he seldom 
is) and the size of the account justifies the incidental expense, 
there are professional adjusters who make it a business to 
handle such accounts. 

The Amicable Adjustment 

To facilitate an orderly discussion of the subject, let us 
first assume that the information discloses that the debtor has 
a large equity in his business, that is, an actual surplus of 
total assets over total liabilities, but that his present condition 
is such that he is unable to meet his current obligations as they 
fall due. This condition is generally due to his having an 
insufficient amount of available working capital, which in 
turn may have resulted from his overstocking, too liberal 
extension of credit, carelessness in following up his collections, 
or any one of numerous other causes, and all that is required 
is time and patience on the part of his creditors in order to give 
him an opportunity to work out a readjustment of his finances. 

When a debtor is thus situated, it behooves the credit man 
to act with the utmost care before resorting to any drastic 
action which would bring about the bankruptcy of an honest 
debtor. Owing to the degree of risk necessarily involved in all 
business, such situations are practically inevitable and are 
oftentimes due to conditions absolutely beyond the control of 
the debtor. Furthermore, such debtors are at least entitled to 
the moral support and moral assistance of their creditors, par¬ 
ticularly those who over a period of years have profited from 
their business relations with the debtor. 

What an Amicable Adjustment Implies 

A personal adjustment implies an amicable or friendly 
settlement. The adjuster, representing the creditor, comes as a 
personal representative of the house, armed with authority to 
settle any points in dispute, to smooth over difficulties, and 


44§ 


INSOLVENCY PROCEEDINGS 


above all else to effect some satisfactory adjustment of the 
account. An expert adjuster, after obtaining the information 
he desires, often knows more about the business of the debtor 
than the debtor himself, and advice is all that is frequently 
needed as a solution of his difficulties. In such instances the 
attitude of the credit man, confident of ultimately obtaining a 
full settlement of his account, should be one of watchful wait¬ 
ing and friendly interest in the readjustment of the debtor’s 
affairs. Such a policy has proved itself not only the most 
profitable in the end, but almost always results in the 
acquisition of a loyal and grateful customer of the house for 
the future. 

Whenever the mistake responsible for the condition of 
affairs can be remedied and corrected with expert assistance 
and the co-operation of creditors, the aim of the adjuster is to 
save the business, as well as to protect the creditors, and this is 
frequently accomplished by having the debtor pay a certain 
percentage of his accounts in cash, and inducing the creditors 
to accept short-term notes for the balance. In event a series of 
notes is given, the type known as the “foot-throttle” note, 
which provides that on default of any one of the series the 
balance become due immediately, is preferable and should be 
insisted upon. Otherwise, each note must be sued on separately 
as it matures. 

Extensions 

If an extension is deemed advisable, it becomes the duty of 
the adjuster to seek to represent and act as agent for all or at 
least a majority of the creditors, because otherwise a settlement 
to be worked out over an extended period may meet with 
serious opposition from a few creditors who may retard the 
consummation of the proposed settlement by neglecting to give 
their assent. This is particularly true when there are numerous 
creditors located at a distance from the debtor. Properly 
handled, however, experience has proved that when such an 


ADJUSTMENTS 


449 


extension is recommended by the adjuster, or adjustment 
bureau, most, if not all, of the creditors will give their consent 
to the proposed arrangement, realizing that the adjuster is 
acting impartially and seeking to obtain for them the most 
advantageous settlement possible. 

If an extension is to be arranged, one of several methods 
may be followed. A trust agreement may be entered into 
between the debtor and the adjuster in behalf of the creditors. 
In such a case the bureau usually asks the creditors to assign 
their claims to it, because once this has been accomplished the 
debtor has only the one creditor to deal with instead of a large 
number, and it serves to relieve the constant apprehension of 
one or two creditors insisting upon a prompt settlement or 
threatening to take drastic action to protect their interests. 
The agreement may provide for a continuation of the business 
by the debtor himself or by a representative of the bureau. 
In this way the co-operation of creditors is assured, and it then 
becomes an easy matter to secure co-operation on the part of 
the debtor also. But should he remain obdurate and compel 
the adjuster to resort to legal measures, such action is simplified 
because the creditors are cemented by a common interest and 
act as an individual through the medium of the adjuster. This 
is seldom the case, however, and usually the debtor realizes 
that it is to his best interests to co-operate with the adjuster. 

Legal Aspects of Extensions 

The question may arise in the minds of either the creditors 
or debtor as to whether an agreement for an extension of time 
is binding on the creditors. Every contract or agreement to 
be binding must be supported by some consideration. So, 
obviously, an agreement by one creditor to give a debtor an 
extension of time, without any consideration, is not binding on 
the creditor. Where, however, several creditors agree among 
themselves and with the debtor, that in consideration of each 
creditor’s forbearance each of the other creditors will agree to 


450 


INSOLVENCY PROCEEDINGS 


an extension, there is sufficient consideration to support the 
promise of each creditor; and no one creditor, at least without 
the consent of all others, would have the right to demand pay¬ 
ment before the extended time had expired. 

When the Cause of Insolvency Is of a Permanent Nature 

Under certain circumstances it would be unwise for 
creditors to grant any such extension. This is obviously true 
when the investigation discloses that the debtor’s affairs are 
badly involved, or where the statement shows an actual deficit 
to exist. In such cases a real adjustment becomes necessary. 

Composition Settlements 

Sometimes it is possible for the debtor to arrange for what 
is called a “composition settlement’’ with his creditors, whereby 
he resumes charge and ownership of his business freed from 
the claims of his creditors. This consists of an agreement 
between the debtor and his creditors (not necessarily all) 
whereby each of the creditors, in consideration of each other’s 
promise to do likewise, agrees to release the debtor from his 
entire debt upon receiving partial payment from the debtor. 
The confirmation of such a composition is in effect a discharge, 
or release, resulting from mutual consent and valuable con¬ 
sideration, and not by operation of law, as in the case of 
bankruptcy compositions. 

The composition settlement is usually brought about on the 
initiative of the debtor, who submits terms of compromise. 
The proposition may be made to the creditors individually, or 
at a creditors’ meeting called for the express purpose of con¬ 
sidering the debtor’s proposal. The latter is more conducive to 
success, for when the creditors are numerous and scattered 
abroad, a few will generally be found who are not amicably 
disposed toward the debtor and this always presents an obstacle 
to the bringing about of such a settlement. Offers of com¬ 
posite settlements should never be considered by creditors when 
any suspicion of fraud attaches to the insolvency. 


ADJUSTMENTS 


451 


When to Agree to a Composition 

This form of settlement is to be highly commended, and the 
creditors should agree to such a settlement, under proper con¬ 
ditions, for two reasons. 

First, This form of settlement is due the honest debtor. The 
creditor is in a way a partner in the debtor’s business, and losses 
must be expected in business. An honest debtor’s offer should 
be encouraged and accepted so that the debtor may regain his 
business and save himself and family from disaster. 

Second. It is to the interest of the creditor to have a settle¬ 
ment made in this form. To illustrate, let us assume that a 
merchant has a business which shows a relation of 75 per cent 
assets to liabilities. The business may be worth 75 per cent of 
the liabilities as a going concern. But in forced liquidation the 
assets would realize much less than their book value. If the 
business went through bankruptcy, the creditors would consider 
themselves fortunate to receive 20 per cent. How much more 
fortunate is the creditor who accepts a settle ment of 40 per cent 
and leaves the debtor 35 per cent to continue and rehabilitate 
his business. Moreover, the loss sustained by the creditor may 
be recouped in future sales to the debtor. This would be quite 
unlikely, if not impossible, were the debtor forced through bank¬ 
ruptcy. Then, too, bankruptcy proceedings use up the time of 
all parties and cause many creditors considerable trouble and 
worry, all of which is dispensed with through the composition 
settlement. 

To summarize, an honest debtor is rightfully entitled to a 
composition settlement. However, before accepting an offer 
of settlement the creditors should obtain full and complete infor¬ 
mation regarding the debtor’s affairs, and assure themselves 
beyond a reasonable doubt that there is an entire absence of 
fraud. If the credit man discovers any trace of fraud he should 
absolutely refuse to grant an extension or agree to accept a 
composition settlement. 1 

Forcing a Composition Settlement on Obstreperous Cred¬ 
itors 

Suppose 75 per cent of the creditors agree to accept the 
terms of composition submitted by the debtor, but the other 


1 Ettinger and Golieb, Credits and Collections, p. 316. 



452 


INSOLVENCY PROCEEDINGS 


25 per cent refuse? In such a case it is possible to force the 
proposed settlement upon the other creditors. Suit is filed by 
three of the creditors in the federal district court to have the 
debtor adjudged a bankrupt. Then, before the adjudication, 
the debtor asks for a creditors’ meeting for the purpose of 
considering an adjustment, whereupon the court stays the 
proceedings. 

At the meeting the debtor is first examined by the creditors 
and then submits his terms of settlement. A majority of the 
creditors in number and amount then agree to accept his prop¬ 
osition, and petition the court to have it confirmed. In this 
way the debtor obtains the desired relief without incurring the 
stigma incidental to being adjudged a bankrupt. Prudent and 
experienced credit men will always insist upon the money being 
put up or satisfactorily secured before voting to accept any 
such proposition. 

Liquidation of Business 

If an extension is deemed inadvisable and no terms of 
composition can be agreed upon, there remains but one other 
course to pursue—wind up the business and distribute the pro¬ 
ceeds among the creditors. This result can be accomplished in 
either of three ways: (1) through the medium of an adjust¬ 
ment bureau, (2) by the debtor making a legal assignment, 
or, (3) through the bankruptcy proceedings. 

Bureau Procedure 

The plan of the adjustment bureau, while accomplishing 
the same purpose as the legal assignment, or bankruptcy pro¬ 
ceedings, dispenses with the most objectionable feature of legal 
process in that it: (1) leaves no stigma attached to the debtor, 
(2) the incidental expense of administering the estate is 
usually much smaller, and (3) the proceeds derived from the 
sale of the assets is considerably larger. 

The bureau plan provides for an assignment by the debtor 


ADJUSTMENTS 


453 


of all his property to the bureau as trustee. The bureau then 
takes charge of the assets, and proceeds to dispose of them in 
one of three ways: 

1. It may sell the goods and fixtures at public auction. 

2. It may sell the stock in small lots to buyers of bank¬ 

ruptcy stocks and storekeepers at private sale. 

3. It may continue the business and gradually dispose of 

stock at retail. 

Whichever method is followed, the creditors are usually 
compelled to wait at least four months after the assignment 
before they receive any dividends. This is for the reason that 
the adjustment bureau does not want to assume any risk should 
certain previously unheard of creditors appear and demand 
payment after the debtor’s estate has been wound up, but 
before the four months’ period has elapsed. These creditors 
could file a petition in bankruptcy and set aside the assignment 
as a preference, and compel the adjustment bureau to account 
for the money received from the sale of the bankrupt’s prop¬ 
erty and disbursed to creditors. The bureau would then be in a 
very embarrassing position if it had already distributed the 
money. It is for this reason that the bureau makes no pay¬ 
ments until at least four months after the assignment. 

Facilities of Adjustment Bureaus to Conduct Liquidation 

Established adjustment bureaus usually have skilled 
appraisers to place in charge of insolvent estates and special 
avenues through which stocks of merchandise can be disposed 
of to greatest advantage. Ordinarily the charges of the bureau 
do not exceed 7 per cent of the amount distributed to creditors 
except where services of an unusual nature are rendered. 1 he 
average return to creditors from liquidations conducted by 
adjustment bureaus usually varies from 50 to 60 per cent of 
the amount of their claims as compared with an average return 
of approximately 25 per cent in bankruptcy. 

Consequently, this process of adjustment is rapidly grow- 


454 


INSOLVENCY PROCEEDINGS 


ing more popular, and adjustment bureaus everywhere are 
growing in number and importance, as it obviously works to 
the mutual advantage of both debtor and creditors, in that it 
requires less time and expense to work out the same result that 
is accomplished through the legal assignment or bankruptcy. 
It is also more in keeping with the constructive business policy 
of the present day—to assist the debtor when he gets into a 
tight place, or “to try to pull a man out of a hole,” and not to 
try to push him into one—as contrasted with the hasty and 
intolerant policy of creditors under the same circumstances 
prior to the enactment of the National Bankruptcy Act, which 
makes it impossible for one creditor to obtain a preference 
through legal process within four months prior to the filing of 
a petition in bankruptcy. In fact, today, once a debtor is in 
financial straits, any attempt on the part of a creditor to force 
a settlement of his claim in such a manner as to obtain a 
preference to the assets at the expense of the other creditors 
usually results in bankruptcy proceedings being instituted by 
the other creditors. 

Many of the various lines of trade, realizing and appre¬ 
ciating the advantages of such settlements, are organizing 
within their respective industries for this very purpose, by 
establishing local representatives or secretaries in all of the 
larger cities. The National Association of Credit Men has also 
been instrumental in encouraging such adjustments by estab¬ 
lishing local adjustment bureaus within their own organization. 

Aims and Objects of Adjustment Bureaus 

The affairs of involved debtors are constantly being 
liquidated through the adjustment bureaus of these local 
associations, the fundamental aims and objects of which are 
as follows: 

i. To investigate, upon request, the affairs of a debtor re¬ 
ported to be insolvent and adjust the estate, when pos¬ 
sible, without court proceedings. 


ADJUSTMENTS 


455 

2. To secure capable and efficient receivers or trustees 

when court proceedings are found necessary. 

3. To secure quick adjustment of all honest failures at the 

minimum cost and with the maximum dividend to 
creditors. 

4. To facilitate and provide for extensions or liquidations 

when upon investigation it is found to be to the best 
interests of all. 

5. To influence concerted action by the creditors for the 

benefit of all. 

6. To assist creditors to acquire for their own use the 

estate of failing or insolvent debtors, when mutually 
agreed upon. 

7. To prosecute or assist in the prosecution of the guilty 

party or parties where investigation discloses fraud 
or the intent to defraud. 


CHAPTER XXXVIII 


ASSIGNMENTS 

Advantages of Assignment 

In the general assignment for the benefit of creditors we 
find combined many of the advantages of the “amicable adjust¬ 
ment” coupled with some of the legal formalities of bankruptcy. 
The expense of administration is less than that of bankruptcy 
proceedings, as under a voluntary assignment there is no limit 
on the time in which an estate must be settled, so that the 
creditors may conduct the business as they see fit, and wait for 
a favorable market in which to dispose of the assets, whereas 
in bankruptcy it is generally necessary to dispose of the assets 
at a forced sale, and at a great discount. Furthermore, while 
greater publicity is given to a formal assignment than is neces¬ 
sary in the case of an adjustment, there is less publicity attached 
to it than to bankruptcy proceedings, because while the admin¬ 
istration of an assignment is practically private, once due notice 
has been given, bankruptcy proceedings are of course a matter 
of public record. 

State Insolvency Laws 

Whether a man could be discharged from his debts 
depended at one time upon state insolvency laws, but these 
laws have been superseded by the Federal Bankruptcy Act. 
Today you cannot obtain a discharge from your debts by 
operation of state insolvency laws, but only by operation of 
the United States Bankruptcy Law. 

In the absence of Congressional legislation on the subject 

456 


ASSIGNMENTS 


457 


of insolvency, the legislation of the respective states is supreme 
within the jurisdiction of the state. In other words, the mere 
grant to the federal government of power over a subject does 
not necessarily extinguish state authority over the same 
subject. But state insolvency laws apply solely to contracts 
made within the state. Consequently, the question here is one 
of proper jurisdiction, and no state has the right or power to 
exercise authority outside its own jurisdiction. Therefore 
interstate matters are beyond state jurisdiction and are exclu¬ 
sively under the control of Congress. Expressed judicially, 
this principle has been stated as follows: “Insolvent laws of 
one state cannot discharge the contracts of citizens of other 
states, because they have no extra-territorial operation or 
effect.” 

Every state, however, has some form of insolvency law, 
whereby a debtor may turn over his property to a third party 
for the purpose of disposal and pro rata division of the pro¬ 
ceeds among his creditors; but the laws are not uniform, and 
the requirements in some states are more exacting than in 
others. For instance, in some states an act of assignment in 
itself automatically releases a debtor from further liability, 
while in others it does not. In most states, however, the law 
provides that the assignment must be recorded in the county 
clerk’s office in which the debtor resides or has his principal 
place of business, and, as in bankruptcy, a sworn schedule 
consisting of a list of creditors and an inventory of the prop¬ 
erty must be filed in like manner. 

The administration of the estate is carried out by the 
assignee under the supervision of, and subject to the discretion 
vested in, the insolvency judge, who can authorize the filing of 
suit for the recovery of property transferred to defraud cred¬ 
itors; the payment of dividends; approval of composition 
settlements; can restrain the debtor or witnesses from leaving 
the jurisdiction; in fact he may exercise practically all the 
powers vested in a court of equity. 


45 8 INSOLVENCY PROCEEDINGS 

An Assignment an Act of Bankruptcy 

Perhaps the most important feature to be brought out in 
this connection is that an assignment, irrespective of the 
debtor’s solvency, as we shall soon learn, constitutes an act 
of bankruptcy, making it possible for the creditors, by filing a 
petition under the Federal Bankruptcy Act, which of course 
supersedes any state law, to take the administration of the 
property out of the jurisdiction of the state insolvency court 
and place it in the hands of a trustee in bankruptcy. Creditors 
seldom avail themselves of this privilege, however, simply 
because under liberal state laws it has generally been found less 
expensive to permit the assignee to continue, especially when 
satisfied of the good faith of the debtor and the honesty and 
ability of the assignee. 

However, it should be remembered that if you consent to 
the making of an assignment you are estopped from filing such 
a petition in bankruptcy. So consent to an assignment should 
be given only when you have absolute faith in the assignee. 
Although selected by the assignor, the assignee is supposed to 
act in the interest of the creditors; but the only way in which 
creditors can bring pressure to bear on an assignee is by making 
proper application to the court for a report or for an ac¬ 
counting. 

Assent on the part of creditors is not necessary to proceed 
with assignment proceedings; it only serves as a protection to 
the assignee, in that in the absence of such assent the estate, 
after settlement, may be thrown into bankruptcy and the court 
may take exception to some of the expenditures and hold the 
assignee accountable. 

This is a difficult subject to treat owing to the lack of uni¬ 
formity in procedure and remedy in the different states. The 
reader will have formed a better conception of assignments 
after having read the following chapters which pertain to the 
process of administration and the manner of handling insolvent 
estates. 


ASSIGNMENTS 


459 


Legal Significance 

Voluntary assignments for the benefit of creditors are 
transfers in trust,’ without compulsion of law, by debtors of 
some or all of their property to an assignee, to apply the same, 
or the proceeds thereof, to the payment of some or all of their 
debts, and to return the surplus, if any, to the debtor. They 
have the effect of withdrawing the property of the debtor from 
the legal pursuit of creditors, and are usually resorted to by 
debtors who find themselves unable to pay their creditors in 
full, or the embarrassed state of whose affairs has compelled 
them to discontinue the transaction of business. 

Debtor’s Right to Assign 

The general power or right to assign property in trust on 
behalf of and for the benefit of creditors has always been recog¬ 
nized and approved in the fullest manner, by both the various 
state and federal courts. The only checks or restrictions placed 
on the exercise of the power were the general ones providing 
for the setting aside of assignments on the ground of fraud. 

State Statutes 

The privilege thus afforded insolvent debtors has, however, 
been taken advantage of to accomplish purposes for which it 
was never intended, and it was the attempt to correct various 
abuses arising out of this recognized legal right that has led 
in most states to the enactment of statutory regulations limiting 
on the one hand the debtor’s power in creating these trusts, 
and defining, on the other, the duties of the assignee in exe¬ 
cuting them; and at the same time giving the creditors a more 
effectual power of inspection and control over the acts and 
proceedings of both. Whereas these statutory provisions differ 
in the various states, they are concerned largely with such 
formal requisites as the filing of an inventory and bond, pre¬ 
senting of an accounting by the assignee, the regulation of 
the time and mode of sale of assigned property, and prefer- 


460 


INSOLVENCY PROCEEDINGS 


ences made or created by the debtor in contemplation of 
insolvency. 

Insolvency—Meaning and When Important 

It is one of the fundamental consequences of the owner¬ 
ship of property that a man may make any disposition of it he 
may desire which does not interfere with the existing rights 
of others. So the state statutes which have been enacted for 
the purpose of restraining the right of making assignments 
and regulating their operation are confined to assignments 
made by debtors who are insolvent or acting in contemplation 
of insolvency. When, therefore, an attempt is made to bring 
an assignment within the operation of these acts, either for 
the purpose of having it declared fraudulent and void, or for 
the purpose of compelling an administration of the assigned 
property in accordance with its provisions, it becomes essential 
to establish the fact that the assignment was made by an 
insolvent debtor or in view of insolvency. This question 
frequently becomes of great importance in considering the 
validity of assignments executed by corporations. 

Insolvency may be either absolute, in the sense that the 
entire mass of the debtor’s resources, including property of 
every description, falls short of satisfying his existing obliga¬ 
tions; or temporary, in the sense that the debtor is no longer 
able to meet his obligations as they fall due, in the ordinary 
way; that is, to satisfy them without resorting to the general 
mass of his property or fixed assets. To constitute insolvency 
within the meaning of the various insolvency laws, it is gen¬ 
erally held that a debtor’s means or entire resources, including 
not only his quick, but also his fixed assets, must be ’inadequate 
for the payment of all his debts. 

In addition to the mode of payment, the circumstance of 
time of payment constitutes an important element in the legal 
meaning of insolvency. In strictness, the term imparts a pres¬ 
ent inability to pay; it is descriptive of a present and not a 


ASSIGNMENTS 


461 

future condition of affairs. In other words, a debtor may be 
able eventually to satisfy his obligations in full, but it does not 
follow that he is not insolvent because of the existence of such 
an ultimate possibility. On the other hand, a solvent debtor 
is never entitled to procure a delay by means of a transfer of 
his property, whether the transfer be by way of a general 
assignment or otherwise. 

Who May be Assignee 

The assignment may be made either to one who is a cred¬ 
itor of the assignor, or to one who is not a creditor; and where 
no assignee is named in the assignment the assignee will be 
selected by the court. However, the power to select and appoint 
his own assignee is allowed to every debtor contemplating such 
a disposition of his property, and in the absence of any statu¬ 
tory restriction he is not bound to consult his creditors or 
obtain their consent to the appointment, provided the person 
selected is qualified and capable of performing the duties of 
the office. 

What Property Passes by Assignment 

A general assignment for the benefit of creditors is under¬ 
stood to import a transfer of all the debtor’s property for the 
benefit of his creditors. The nature of the relation created by 
insolvency requires that the transfer should be of this compre¬ 
hensive character, inasmuch as creditors then have an equitable 
claim on all the property of their debtor, and it is his duty to 
devote the whole of it to the satisfaction of their claims. 

There are, however, portions of a debtor’s property which 
the law expressly exempts from the process of creditors; and 
these, of course, he is allowed to except and retain out of the 
general conveyance. Statutory provision is usually made for 
these exemptions, but it has been held in several jurisdictions 
that unless specific reservation of such property is made in 
the conveyance, the right is waived by the debtor. 


462 INSOLVENCY PROCEEDINGS 

Form of Assignment 

A writing of some kind is generally required, not only as 
security against fraud or collusion, but as a necessary means 
of giving effect to the assignments themselves. The very 
nature of the transfer, comprehending various descriptions of 
property, and accompanied by directions more or less numer¬ 
ous and complicated, as to the mode of distribution, renders 
a written instrument important. Where real property is either 
wholly or in part the subject of the assignment, a writing is 
expressly required by statute. In fact, in most states it is 
expressly required by statute that every assignment for the 

Know All Men by These Presents, that Whereas, I, .of., 

am indebted to divers persons in considerable sums of money, which I 
am at present unable to pay in full, and am desirous to convey all my 
property for the benefit of all my creditors without any preference or 
priority. 

Now, Therefore, I, the said., in consideration of the premises, 

and of one dollar to me paid by., of., the receipt whereof 

is hereby acknowledged, have granted, bargained, sold, assigned, trans¬ 
ferred, and set over, and by these presents do grant, bargain, sell, assign, 

transfer, and set over, unto the said., all my lands, tenements, 

hereditaments, goods, chattels, property, and rights in action of every 
name, nature, and description, wheresoever the same may be, except such 
property as is by law exempt from execution. 

To Have and to Hold the same unto the said., in trust, to sell 

and dispose of the. said real and personal property, and to collect the said 
rights in action, with the power to compound for the said rights in action, 

taking a part for the whole, where the said.shall deem it expedient 

so to. do, and then in trust to apply the proceeds of the said property 
and rights in action in the following manner: 

1. To pay the costs and charges of these presents, and the lawful ex¬ 

penses of executing the trust hereby created, and the wages or salaries 
actually owing to the employees of the said. 

2. To distribute and pay the remainder of said proceeds to the creditors 

of me, the said., for all debts and liabilities which I may be owing 

or indebted to any person whatever; provided, however, that if there shall 
not be sufficient funds with which, to pay all my said debts, then the said 
debts are to be paid ratably and in proportion. 

3. The residue, and remainder of said, proceeds, if any there be, after 

paying all my said debts in full, the said.is to repay to me, or to 

my executors, administrators, or assigns. 

In Witness Whereof, I have hereunto set my hand and seal, this 

--.day of. 

In the presence of 

(Witnesses’ signatures.) [Seal] 

Form 27. General Assignment for Benefit of Creditors 















ASSIGNMENTS 


463 

benefit of creditors should be in writing, and further formali¬ 
ties are in some instances required. 

In regard to the particular character of the writing by which 
an assignment is required to be evidenced, it usually partakes 
of the character of a deed (Form 27), and is drawn with the 
same care as any other instrument of conveyance; consisting 
of two principal parts: (1) a transfer to the assignee, which 
vests in him the property; and (2) a declaration of trust, which 
directs him how to dispose of it. The component parts of the 
transfer are: (1) the commencement, (2) the recital, (3) the 
consideration, (4) the transfer, (5) description of property, 
(6) declaration of trust, or directions to assignee, (7) power 
of attorney to the assignee, (8) covenant by the assignee, and 
(9) the concluding clause. 

To the assignment are usually appended two schedules 
which are marked and referred to in the body of the instru¬ 
ment, and are accepted as part of it: (1) a schedule of the 
assigned property, and (2) a schedule of the assignor’s credi¬ 
tors, or of the debts to which the property is to be appropriated. 

Assignments with Special Provisions—Release of Debtor 

Assignments are sometimes drawn with a stipulation for a 
release of the debtor as the condition of receiving the benefit 
of the deed; or, in other words, making it a condition that the 
creditors shall accept the provision made for them in full satis¬ 
faction and discharge of their demands. Such a stipulation 
is in some cases introduced as a condition of receiving any 
benefit under the assignment, non-releasing creditors being 
wholly excluded, and expressly reserving the shares of non¬ 
releasing creditors to the assignor himself. 

As to the validity of such stipulations, the law is not uni¬ 
form. In some states such a release has been sustained; in 
others they have been adjudged valid only in so far as they 
operate to postpone non-releasing creditors to others. In other 
states they have been pronounced void under all circumstances, 


464 


INSOLVENCY PROCEEDINGS 


especially where there is an express reservation of the surplus 
to the assignor. 

The objection to the allowance of these stipulations in 
assignments is that when allowed the debtor surrenders noth¬ 
ing except on his own terms. He attempts to coerce his 
creditors by withholding from them all his property, unless 
they accept what he is able to give in discharge of his debts, 
and thereby succeeds in locking up his property until the 
creditors comply with his terms. 

Reservation of Benefit to the Debtor 

“When a debtor fails, his property, in moral justice, belongs 
to his creditors.” Assignments of his property, therefore, con¬ 
sidered as modes of provision for creditors, should actually be 
what they profess to be, for the benefit of creditors, and not 
for the benefit of the debtor. Hence, it has been generally 
held that any clause or provision in an assignment whereby 
any advantage is reserved to the debtor at the expense of his 
creditors, constitutes fraud, and vitiates the assignment. From 
this general doctrine it follows that an insolvent debtor can 
make no assignment of any part of his property in trust for 
himself, and that all such deeds or transfers are void as against 
creditors. 

Limitation of Time for Creditors to Assent 

Assignments are sometimes drawn with a provision requir¬ 
ing the creditors for whose benefit they are made, to assent to 
them within a limited time. As to the validity of such a 
reservation, the various state decisions on the point are not 
in accord. When allowed, however, the time so limited must 
be a reasonable period. What is to be deemed a reasonable 
time depends upon the particular circumstances surrounding 
the case. The period may be either so short or so long as to 
raise a presumption of fraud. It must be neither too long, 
so as improperly to delay the creditors in the collection of their 


ASSIGNMENTS 465 

debts, nor so short as not to afford sufficient time for a proper 
investigation. 

The same restrictions apply with respect to the sale of the 
property assigned, and a clause unreasonably postponing the 
time of sale of the assigned property will void the assignment. 
The assignee has a discretion as to the time of sale, but it is a 
legal discretion subject to the control of a court of equity. 

The manner of sale, as well as the time and terms of sale, 
is almost always left to the discretion of the assignee, who is 
authorized to sell “in such manner, at such time, and subject 
to such terms as he shall deem most expedient in the interests 
of the creditors.” 

Consideration for Assignments 

There can be no question as to whether an assignment of 
a debtor’s property to a trustee, or assignee, for the benefit of 
his creditors is for a valuable consideration or not, because 
the debts due to the creditors constitute a valuable and sufficient 
consideration, and the obligations voluntarily assumed by the 
assignee or trustee likewise constitute an adequate consideration 
so far as he is concerned. 

The principal trusts of every assignment are to collect the 
property; to convert it into money by sale, and to distribute 
the proceeds among the creditors entitled to participate in the 
assets. But these main trusts are oftentimes varied by the 
assignor as the circumstances may necessitate, and usually are 
subdivided into minor trusts, or specific directions pertaining 
to the disposition of the property. 

Execution of the Assignment 

The assignment having been properly prepared and the 
necessary schedules attached, the next step in the proceeding is 
the execution of it by the persons named as parties. In most 
cases the instrument is under seal and where it conveys realty, 
or contains covenants by either party, this formality should not 


466 


INSOLVENCY PROCEEDINGS 


be omitted. The schedules should be dated and executed, as 
well as the assignment itself. 

The assignment should, in the first place, be executed by 
the assignor, although it may be done by an attorney acting 
under a valid power for the purpose. Where the assignee is 
formally named as a party to the assignment, or the instrument 
contains any covenant to be performed by him, it is necessary 
that he should execute it as well as the assignor. But when 
this is not the case, he need not become a party to it by signing. 
In other words, an assignment is good, even if the assignee 
does not execute it or enter into any covenant to perform the 
trusts. If it is executed by the assignor and delivered to the 
assignee, and he accepts it and enters upon the performance of 
the trusts, he is as much bound as if he had executed it. 

1 

In some states a formal acceptance by the assignee at the 
foot of the deed, immediately following the signature of the 
assignor, is required. 

Attestation 

The assignment, like all other conveyances of property, 
should be executed before witnesses, who attest it in the usual 
manner. In some states it has been made necessary to the 
validity of an assignment that it should be sworn to by the 
assignor. 

Recording or Registry of the Assignment 

Record Essential. In some of the states an assignment 
is of no validity against creditors unless recorded or registered 
in some public office within a certain time after its execution. 

Where real property is part of the property assigned and is 
situated in a county other than the one in which the original 
assignment is required to be recorded, a certified copy of such 
assignment must be filed and recorded in the county where such 
property is situated. 

Delivery of the Assignment. It is also necessary, in 


ASSIGNMENTS 


467 


order to complete the transfer intended by the assignment, that 
the instrument should be actually delivered to the assignee. 
Otherwise, it has been held to be fraudulent and void against 
a creditor who has obtained a judgment. The record of the 
deed amounts to prima facie evidence of delivery, and the 
moment an assignment is submitted for recording, the bene¬ 
ficial interest of the creditors is completely vested. 

Delivery of Property. The acceptance of the assign¬ 
ment by the assignee after its execution and delivery by the 
assignor completes the proceedings necessary to the transfer 
between those parties, so far as the instrument itself is con¬ 
cerned; but there usually remains a very important act to be 
done, namely, delivery of possession of the property. This 
should follow as closely as practicable the execution of the 
instrument. This is particularly desirable in regard to personal 
property, the real estate assigned passing by mere delivery of 
the deed. 

It is not an uncommon practice, however, for the assignor 
to retain possession after the assignment; and the general ques¬ 
tion involved is whether such retention of possession of goods 
assigned is fraudulent, and therefore void as against creditors. 
The decisions of the state courts on this point are quite diverse. 
The general rule has been laid down in the federal courts, 
however, that unless possession of the property assigned 
accompanies or follows the deed, such a transfer is fraudulent 
and void against creditors. 

In regard to goods or personal chattels, a constructive or 
symbolical delivery is allowed where an actual delivery is 
physically impracticable, for example, where the goods are 
aboard a vessel, or in possession or custody of some third party 
under some lawful title. 

Assent of Creditors 

Where the assignment is made directly to the creditors, 
their assent is always required to give it validity, on the ground 


468 


INSOLVENCY PROCEEDINGS 


that it requires the agreement of two parties to make a contract. 
A debtor cannot change his relation to his creditors by a volun¬ 
tary assignment of his property to them. If, therefore, he 
makes an assignment direct to them and his creditors do not 
accept it, there is no change of property, and legal redress is 
open to the creditors as before the attempted assignment. 

But where the assignment is to a trustee for the benefit of 
creditors not parties to the deed, the general rule is that the 
assent of the creditors is not necessary to its validity, and the 
legal estate or title will pass to the assignee without such assent, 
so as to prevent a judgment creditor from acquiring a lien by 
his judgment on the realty, or levying an execution on the 
personalty. 

The assent of the creditors may be given either by formally 
consenting to the assignment, or by receiving and accepting the 
benefit of it. Where a specific time is prescribed for the cred¬ 
itors to assent, they must comply strictly with the condition, 
or they will be excluded from the benefit of the trust. 

Where the assent of creditors is required by law, or by the 
form of the assignment itself, it is not necessary that all should 
assent, in order to make the instrument valid. The prevailing 
doctrine seems to be that only the assent of creditors in suffi¬ 
cient number and amount to cover the value of the property 
assigned is required. 

Proceedings by the Assignee 

The assignee, on receiving the assignment from the debtor, 
immediately enters upon the duties of the office by giving 
public notice of the assignment (when necessary), executing 
a bond for the faithful performance of the trust and taking 
possession of the property specified in the schedule. Proper 
measures are then taken for the collection of the debts assigned 
and the disposal of the property at the earliest practicable 
period. Out of the proceeds of the sale, after deduction for 
the expenses of the trust, distribution is made among the credi- 


ASSIGNMENTS 


469 

tors, and dividends are usually paid from time to time as the 
funds accumulate in the hands of the assignee. If any surplus 
remains after paying all debts, it is paid to the assignor, and 
the trust is closed by a general accounting. 

The duty of the assignee is to proceed with as little delay 
as possible, consistent with the best interests of creditors, in 
converting the assets into money and applying same in the 
payment of the creditors. In the execution of the trust, he 
must be governed by the directions contained in the assignment 
itself (when they are not inconsistent with statutory pro¬ 
visions), subject to such supervision as may be exercised by 
the proper court; and in general he is bound to manage and 
execute the trust for the benefit of creditors with the same 
degree of care and diligence as a prudent owner. 

The assignee is personally responsible for an abuse of the 
trust, and if guilty of misconduct, may be called to account, and 
if necessary, removed from his office. But he is protected 
when he acts in good faith, even under a void assignment. 

Notice of the Assignment to Creditors 

One of the first acts of the assignee on receiving the assign¬ 
ment is to give public notice of it, which is usually done by 
advertisement in one or more newspapers, stating in substance 
that the debtor has made an assignment of all his estate to the 
assignee for the benefit of his creditors, and requesting credi¬ 
tors to present their claims, and debtors to account and make 
payment to him. 

In most states public notice of the assignment is expressly 
required by statute. On the other hand, in some states the 
recording of an assignment is held to constitute sufficient notice 
to creditors. 

Object and Effect of Notice 

The object of giving notice of the assignment is to give 
publicity to the transaction for a twofold purpose: (1) to 


470 


INSOLVENCY PROCEEDINGS 


apprise the creditors of the transfer and to instruct them as 
to their proceedings to obtain its benefit; and (2) to inform 
the debtors of the assignor and persons having money or prop¬ 
erty belonging to him in their hands, of the party to whom they 
are to account and to pay the same. 

A debtor on an open account, after notice of the assign¬ 
ment, cannot defeat the rights of the assignee by making 
payment to the insolvent debtor. 

Effect of Omission of Notice 

The neglect of the assignee to give the public notice 
required by the assignment does not divest the title to the 
property assigned, and it has been held not to be necessary that 
the creditors for whose benefit the assignment is made should 
have notice of it, provided they afterwards assent to the pro¬ 
visions made for their benefit. 

Extent to Which Assignor’s Business May be Continued by 

Assignee ' 

As a general rule, the effect of a general assignment of a 
debtor’s property is to put an end to the transaction of his 
business as ordinarily conducted—to the ordinary operations 
of purchase, manufacture, and sale. Provision is oftentimes 
made, however, in the instrument of assignment providing for 
the continuation of the business for a limited time, with a view 
to the more beneficial execution of the trust. 

Independently, however, of any authority contained in the 
assignment, the assignee may, in certain cases, continue the 
business as it has been conducted by the debtor. Thus, where 
an assignor is conducting a manufacturing business when he 
makes an assignment, and he has a large amount of material 
on hand for the purpose of being manufactured, the assignee 
can conduct the business in his own name for the purpose of 
working up the material thus ready for manufacture, where it 
is manifestly for the benefit of the estate. But he cannot con- 


ASSIGNMENTS 


471 


tinue the business longer than is necessary for this, particular 
purpose. If he does do so, he does it at his own risk, and may 
be held accountable for any loss which thereby accrues to the 
estate. 

Sale of the Assigned Property 

One of the principal objects of a voluntary assignment of 
property for the benefit of creditors, and one of the most 
important duties of the assignee in the execution of the trust, 
is the sale of the property assigned, in order to convert it into 
money for the purpose of distribution among creditors. The 
property must in all cases be disposed of by sale, nor can he 
appropriate it for his own use, although he charge himself the 
cost price. 

The power to sell is usually expressly given by the assign¬ 
ment. But it is also necessarily implied by every conveyance 
for the payment of debts. 

Duty in Regard to Sale 

The assignee is bound to use not only good faith, but also 
every requisite degree of diligence and prudence in conducting 
the sale. If reasonable diligence is not exercised in conducting 
the sale, or he so manages it as to advance the interest of one 
of the parties to the injury of another, he will be personally 
liable to make good, to the party suffering from his misconduct, 
the amount of the loss. 

Time of Sale 

An assignee is bound to submit the property to sale and to 
pay over the proceeds to those who are entitled thereto without 
delay. If he delays unreasonably to sell, this may be evidence of 
fraud, and the property may be attached or levied upon as the 
debtor’s. On the other hand, it has been held that an assignee 
is not bound to sell within a particular time, but should use his 
discretion in the matter in order to obtain the highest price. 


INSOLVENCY PROCEEDINGS 


472 

Mode of Sale 

An assignee, in general, has discretion to sell at public or 
private sale, as may appear to be in the best interests of credi¬ 
tors. The proper course to pursue, if he cannot sell the prop¬ 
erty at its fair cash value at private sale, is to sell it at auction, 
after giving the creditors reasonable notice of the sale; and 
he cannot delay a sale for the purpose of retailing the goods. 
Where the deed expressly directs him to sell by public auction, 
the assignee is bound to conform to that mode of sale. 

Terms of Sale 

In some of the states the assignee is allowed to sell the 
property for cash or credit, in his discretion, and the assign¬ 
ment itself frequently gives him this power. In other states 
the assignee is forbidden to sell on credit, and a deed granting 
authority to sell on credit will render an assignment void. 

Title of Purchaser 

A bona fide purchaser for value, without notice, under an 
assignment that is not void upon its face, cannot be affected 
by any intended fraud on the part of the assignor. And not¬ 
withstanding the invalidity of an assignment as it respects the 
creditors of the assignor, a sale of goods assigned, made by 
the assignee before the creditors have obtained a specific lien 
upon them, to an innocent purchaser for a valuable considera¬ 
tion, is valid. In other words, the doctrine of caveat emptor 
does not apply to the case of a sale by an assignee for the 
benefit of creditors, whether the property be real or personal. 

Expenses of the Assignment 

The payment of the expenses is usually provided for in the 
assignment, and these the assignee is authorized to deduct and 
retain out of the first funds which come into his hands as 
proceeds of the assigned property. And even where they are 
not provided for in the assignment itself, all the necessary 


ASSIGNMENTS 


473 


expenses of the assignee in execution of the assignment consti¬ 
tute a lien upon the estate, and he will not be compelled to part 
with the proceeds until his disbursements are paid. 

The principal items of expense or disbursement incurred 
in the executions of trusts created by voluntary assignments 
are advertising, insurance, interest, taxes, commissions on 
sales, salaries and wages of employees, rent, and cost of liti¬ 
gation concerning estate property. 

Compensation to Assignee 

In addition to the allowance of his expenses and disburse¬ 
ments, the assignment sometimes contains a provision allowing 
the assignee compensation for his own time and services; and 
this is either fixed at a definite amount or stipulated for in 
general terms. Sometimes a compensation is stipulated for 
by agreement, independently of the assignment. 

Where there is no express stipulation or agreement for 
compensation to the assignee, beyond his expenses, the general 
rule is that he is entitled to a reasonable compensation, which 
is construed in most states to mean the same fixed compensation 
as is allowed by law to executors, trustees, and guardians. 

Where the instrument creating the trust, however, fixes a 
different compensation, or declares that none is to be allowed, 
that, of course, must prevail. 

The compensation of the assignee is to be ascertained and 
awarded by the proper court upon the rendering of his account. 
He is not allowed to become a judge of the value of his own 
services and offset money or goods appropriated from the estate 
in payment of same even where a compensation is provided. 

In regard to fees claimed by the assignee for services 
rendered as counsel, it has been held that a trustee, or assignee, 
cannot charge the estate with a counsel fee paid to himself, 
on the ground that an insolvent assignor cannot give the 
assignee any portion of his estate for his services, beyond the 
fixed legal rate of compensation. 


474 


INSOLVENCY PROCEEDINGS 


Compensation allowed to an assignee is always on the 
supposition and condition that he properly performs the duties 
incumbent upon him as assignee. Hence, if he is guilty of 
gross carelessness or misconduct, or violates the trust, no 
compensation will be allowed him. If he maladministers and 
refuses to account, both compensation and expenses may be 
refused him. 

Distribution among Creditors 

After deducting out of the proceeds of the sales and collec¬ 
tions the expenses incidental to the trust and the amount of 
compensation allowed for himself by law, it is the duty of the 
assignee to distribute without delay the surplus funds in his 
hands among such of the creditors as may be entitled to par¬ 
ticipate. This may be considered the most important proceed¬ 
ing in the whole course of executing the assignment, to which 
the principal processes of collection and sale are only prelimi¬ 
nary. Distribution comprises the whole object and end of the 
assignment. 

The distribution is made either in one payment, or in suc¬ 
cessive payments or dividends. But before any payments can 
be made, it is necessary for the assignee to ascertain what 
creditors are entitled to payment, and the order in which they 
are payable. 

Where there is difficulty in ascertaining from the assign¬ 
ment the amount of debts payable, and the mode and order of 
payment, or where there are conflicting claims which it is diffi¬ 
cult to adjust, the assignee may apply to the proper court for 
directions. Such an application on the part of the assignee 
may be made either by motion or by a bill in equity. 

In inquiring for the debts made payable out of the funds 
in his hands, the assignee looks in the first instance to the 
description of them in the assignment, or its accompanying 
schedules, which are regarded as a part of it, so far as they 
designate the creditors and the amount and nature of the debt. 


ASSIGNMENTS 


475 


But such description is not always to be implicitly relied upon, 
and it has been held not to be conclusive as to the amount of 
the respective debts, and that the books of the assignor are 
proper evidence of the amount of the debts due to the credi¬ 
tors. In some states, the creditors have been permitted to 
introduce other proof explanatory of their claims. 

Disposition of Surplus after Distribution 

If after the payment of all the assignor’s debts which are 
legally payable under the assignment, there is a surplus of the 
proceeds of sales and collections remaining in the hands of the 
assignee, such surplus belongs to the assignor, and the assignee 
is bound to pay it to him. The surplus in no case belongs to 
creditors whose claims have been paid. Therefore, where an 
assignee agreed to collect the assets and pay them over to the 
creditors, it was held that he was not also to pay to them any 
surplus after discharging their debts in full. But if the 
assignee reconvey the property to the assignor before the debts 
for the payment of which the estate was created have been 
paid, the reconveyance is void as to all creditors whose debts 
were provided for by the assignment and remain unpaid at the 
date of the reconveyance. 

Where the assignment imposes certain terms upon creditors 
as the condition upon which they are to receive its benefits, and 
all the creditors do not choose to accede to such terms and do 
not comply with them, it has been held that if a surplus remain 
after satisfying the claims of the acceding creditors, it belongs 
to those creditors who have not acceded to the terms of the 
assignment and a court of equity will award it to them. 

Final Accounting and Close of Assignment 

An essential part of the duty of an assignee is the keeping 
of a strict and full account of all his receipts and payments 
during the course of the execution of the trust; and after all 
the funds collected have been finally appropriated and paid over 


476 


INSOLVENCY PROCEEDINGS 


to those entitled to receive them, he should always be prepared 
to exhibit his accounts to the assignor and the creditors. If 
an assignee neglects to keep a full and accurate account of the 
disposition of the trust property, he will be charged with the 
value of the property sold by him. 

In most states the assignee is expressly required by statute 
to present his account to the designated court for an examina¬ 
tion and approval before he can finally discharge himself from 
the trust, as in the case of executors and administrators. 

Accounting in Equity 

Even in states where no formal accounting is required by 
statute, the creditors are always entitled to an account, and if 
this be refused or insufficiently granted, they may proceed to 
compel an account by filing a bill in equity, or other equivalent 
proceedings. The method of procedure upon such accounting 
is regulated by the practice and rules of courts of equity in the 
different states. The action may be brought in the name of 
any creditor in behalf of himself and all other creditors. 

Close of the Trust 

The time for closing the trust is sometimes fixed by the 
assignment itself. If no time is specified, the assignee is 
allowed what may be considered, under all the circumstances, 
a reasonable time for the purpose. Sometimes the trust will 
be considered as closed by lapse of time; and after 20 years 
the law presumes the debts paid and the trust executed so far 
as respects creditors. 

Liability of Assignees 

The liability of an assignee is commensurate with the duty 
which the assignment imposes upon him. Fundamentally, this 
duty is to observe good faith in all his transactions and to 
exercise reasonable diligence in the management of the trust. 
Hence, a want of good faith or of proper diligence will subject 


assignments 


477 

him to liability for any loss which may result from it. For 
gross misconduct or a violation or abuse of the trust, such 
as a wilful misapplication of the trust funds in his hands, an 
assignee is personally responsible and may be dismissed from 
office. 

Negligence, however, is the ground upon which assignees 
are most frequently held liable. Thus, a trustee is liable for 
property or money lost by his gross negligence. But an 
assignee’s liability is not confined to gross negligence, nor can 
it be so limited by any stipulation on his part in the deed 
of assignment. Consequently, he is liable for every loss sus¬ 
tained by reason of his negligence, want of caution, or mistake, 
as well as for positive misconduct. On this ground of “ordi¬ 
nary negligence” assignees have been held liable for neglecting 
to recover debts assigned, for omitting to recover assigned 
property from the debtor, and for permitting the debtor to 
retain possession of assigned property and receive the proceeds. 

Attitude of the Courts in Dealing with Assignees 

In regard to the mode in which assignees are dealt with by 
the courts, the rule has been laid down that: 

Where trustees act in good faith and with due diligence, 
they receive the favor and protection of the court, and their 
acts are regarded with the most indulgent consideration; but 
where they betray their trust, or grossly violate their duty, or 
where they have been guilty of unreasonable negligence, their 
acts are inspected with the closest scrutiny and they are dealt 
with according to the rules of strict, if not vigorous justice. 

The legal presumption always is that a trustee has faith¬ 
fully executed his trust, until substantial proof to the contrary 
is submitted. 

Proceedings of Creditors—Coming in under the Assignment 

Having considered, first, how the trust for creditors is 
created on the part of the assignor, and, second, how it is 


INSOLVENCY PROCEEDINGS 


478 

executed on the part of the assignee, there still remains to be 
considered the rights of creditors, either under the assignment, 
in opposition to it, or independently of it, and what proceedings 
it is competent for them to adopt for the enforcement of such 
rights. 

On receiving notice of the execution of an assignment the 
creditors have one of three alternatives to pursue: (1) accept 
the provisions made by it; (2) disregard it entirely and proceed 
as though it had not been made; or (3) reject it as fraudulent 
or illegal. 

If they accept the assignment, they come in under it and 
proceed to take such steps for obtaining its benefits as may be 
required of them, either by the provisions of the instrument 
or by the general rules of law applicable to the case. Where 
a specified time is prescribed by the assignment for creditors 
to come in and assent to it, they must comply strictly with the 
condition and cannot come in after the expiration of the time 
stipulated. It has been held in such cases, however, that they 
are not absolutely excluded, but that they can only claim the 
benefit of any surplus which may remain after satisfying the 
claims of those creditors who have complied with the terms 
of the assignment. 

Creditors may express their intention to come in under the 
assignment in several ways: (1) by becoming parties to the 
instrument; (2) by giving notice to the assignee of their 
acceptance of it; or (3) by simply presenting their claims for 
payment. 

By coming in under a voluntary assignment the creditors 
express their election to accept its provisions, and are consid¬ 
ered as acquiescing in the disposition directed by the assignor 
to be made of the proceeds of the property. 

Treating the Assignment as a Nullity 

In cases of apparent fraud or obvious illegality the course 
is sometimes adopted of treating the assignment as a “nullity” 


ASSIGNMENTS 


479 


and proceeding as though it had not been made. The right 
to treat an assignment as a nullity is in some states specifically 
provided by statute. thus, if an assignment is made with 
preferences contrary to the statute,-it is absolutely void, and the 
property remains susceptible to attachment by creditors in the 
same manner as if no assignment had been made. In other 
states the same right is recognized by decisions of the courts. 

Where the assigned property is attached, in such instances 
the assignee may bring an action of trespass, and this will raise 
the question as to the validity of the assignment. In some 
states the validity of an assignment alleged to be fraudulent 
may be tested in a court of law, upon an issue made between 
an attaching creditor and the assignee summoned as garnishee. 

Proceedings to Set Aside the Assignment 

Instead of regarding the assignment as a mere nullity, the 
usual course taken by creditors when the assignment is regarded 
as fraudulent and void as against them, is to oppose it by hostile 
proceedings in the courts, for the express purpose of having 
it judicially declared void and set aside. If the creditor elects 
to have it declared void and set aside judicially, the proper 
procedure consists of filing a bill in equity praying for a decree 
to that effect. The prayer of the bill is usually also for an 
injunction to prevent further proceedings under the assignment 
and for a receiver to take possession of the property or its 
proceeds. 

Who May Oppose the Assignment 

This course, however, is not available to all creditors, nor 
under all circumstances. Thus, none but judgment creditors 
can attack an assignment as fraudulent or invalid. Further¬ 
more, creditors who have confirmed a fraudulent assignment 
by receiving a benefit under it, or have become parties to it 
voluntarily, are estopped from afterwards impeaching it. 

If the creditor who opposes the assignment succeeds in 


480 


INSOLVENCY PROCEEDINGS 


establishing a case of fraud, a decree is made by the court 
declaring the instrument void, and appointing a receiver, 
through whom as its officer the court takes possession of the 
property and appropriates itr Where the assignment is set aside 
for fraud, the assignee will not be answerable for payments 
made under it to bona fide creditors before the filing of the bill. 


CHAPTER XXXIX 


RECEIVERSHIP 

General Nature of a Receivership 

Where a debtor has total assets which exceed in value his 
total liabilities, but lacks sufficient cash to meet his bills as they 
mature, he may seek the protection of the courts from a forced 
sale of his property by impatient creditors, by making appli¬ 
cation for the appointment of a receiver for the business. The 
application may also be made by the creditors; but it not infre¬ 
quently happens that when the creditors applying for a receiver 
learn of the true condition of the debtor at the hearing of 
the application, they agree to an extension and thus save the 
expense of a receivership. Such a receivership does not con¬ 
stitute an act of bankruptcy because the debtor is not insolvent 
within the meaning of the bankruptcy act if his total assets at 
a fair valuation are in excess of his liabilities. 

Instead of seeking the appointment of a receiver, the credi¬ 
tors may petition for an injunction to restrain other creditors 
from impairing the value of the debtor’s estate by suits and 
execution, and if such an injunction will adequately protect 
the rights of all creditors the court may grant the injunction 
instead of appointing a receiver. 

In most of the states statutory provisions have been enacted 
which prescribe the functions, powers, and duties of receivers. 

Effect of the Appointment of a Receiver 

\ 

The object sought by the appointment of a receiver is to 
provide for the safety of property pending the litigation which 
is to decide the rights of litigant parties. In other words, a 

481 


482 


INSOLVENCY PROCEEDINGS 


receiver is a person appointed by the court as its representative 
for the purpose of assuming control over certain property until 
the court shall decide to whom it properly belongs. He is re¬ 
garded as an officer of the court appointing him and whatever 
he does under the orders of the court in respect to the property 
over which he is appointed receiver is the act of the court 
itself. He is frequently characterized as the “arm or hand of 
the court.” A receiver has also been characterized as a quasi¬ 
trustee holding the property for the benefit of whoever may 
eventually establish title to it. A receiver differs from an 
assignee in bankruptcy in that the latter is vested with the 
legal title to property held by the bankrupt, while a receiver 
has no such estate but is a mere custodian for the court. 

Principles on Which a Receiver Is Appointed 

The power to appoint receivers is one vested solely in courts 
of equity, and the jurisdiction of equity to appoint a receiver 
is founded on the inadequacy of the remedy to be obtained in 
the law courts. 

In order for general creditors to have a receiver appointed 
over the property of the debtor, a strong case must be made 
out because the court will not, unless a clear case be established, 
deprive a person of property in which the claimant has no 
specific claim, in order that if he establish his claim as a creditor 
there may be assets wherewith to satisfy it. 

As a general rule, when the object of the action is only to 
compel the payment of a sum of money, the court will not ap¬ 
point a receiver upon the filing of the bill. While it is some¬ 
times necessary for the court, through its receiver, to continue 
the management of the business over which the receiver is 
appointed, for the purpose of effecting a more satisfactory ad¬ 
justment and for better protecting the interests of all parties, 
the courts are generally averse to assuming the management 
of a business except as incidental to the object of the suit, and 
for the purpose of closing it up and dividing the proceeds, 


RECEIVERSHIP 


483 

When a receiver is appointed at the instance of judgment 
creditors, it is customary for the court to require the defendant 
to execute an assignment to the receiver of all his property 
and effects, which has the effect of placing it beyond levy and 
execution by judgment creditors. 

Selection and Eligibility 

In the selection of a person to act as receiver the court 
exercises a judicial discretion which is governed by certain 
well-defined principles. In the first place the receiver is an 
indifferent person to the litigation and not the agent or repre¬ 
sentative of either party to the action. He is regarded as 
an officer of the court, exercising his functions in the interest 
of neither plaintiff nor defendant, but for the common benefit 
of all parties in interest. Being an officer of the court, the 
fund or property entrusted to his care is regarded as being 
in custodia legis (in the custody of the court) for the benefit 
of whoever may eventually establish title thereto. He, there¬ 
fore, occupies a position of dual capacity: (1) as officer of the 
court, (2) in his fiduciary relationship to the parties. 

The person who is to fill the office of receiver is generally 
decided upon prior to the making of the motion, and if both 
parties have agreed upon a proper person, the court will at 
once insert his name in the decree. If the party proposed as 
receiver is objectionable, any person interested in the proceed¬ 
ings may propose that some other person be appointed. In 
making the selection, the circumstances of the case and the 
interests of all parties must be taken into consideration. 

It is regarded as exceedingly objectionable to appoint as 
receiver over a particular kind of property a person who is 
entirely unfamiliar therewith, even though he agrees to carry 
out the directions of another person more familiar with the 
management of the property, since it is always preferable that 
the receiver appointed should act upon his own responsibility. 

The fact that the appointee resides at a great distance from 


484 


INSOLVENCY PROCEEDINGS 


the property which is to be subjected to his management and 
control, while not regarded as an absolute disqualification for 
the office, is a circumstance which should be taken into consid¬ 
eration in making the appointment. In the absence of statute 
it is not necessary that the person selected should be a resident 
of the state in which the suit is pending. 

Receiver’s Possession 

The appointment of a receiver does not in any way deter¬ 
mine the rights of the parties to the litigation, and the title to 
the property does not change by virtue of his appointment. A 
receiver holds the property coming into his hands by the same 
right and title as the person for whose property he is receiver. 
In other words, his possession is not adverse to either the 
plaintiff or the defendant in the litigation; the primary object 
being to secure the thing in controversy so that it may be 
subject to such disposition as the court may finally direct. The 
possession of the receiver is not unlike that of the sheriff 
over property which has been levied upon under an execution or 
attachment. 

It is important to note that the receiver’s possession is 
subject to all valid and existing liens upon the property at the 
time of appointment, and does not divest a lien previously 
acquired in good faith. And when creditors have obtained 
judgments against their debtor, which are a lien upon his 
property, prior to the appointment of a receiver, the receiver 
takes subject to such liens. So, where creditors obtain judg¬ 
ment and levy upon the property of the debtor and a receiver 
is afterwards appointed who takes possession of the property 
and sells it, the sheriff who made the levy is entitled to the 
proceeds of such sale. Likewise a receiver cannot maintain 
replevin for property which has been levied upon and reduced 
to possession by creditors having a paramount lien. 

The receiver’s possession being the possession of the court 
from which he derives his appointment, he is not subject to 


RECEIVERSHIP 


485 

the process of garnishment as to funds in his hands or subject 
to his control, and such process will be regarded as a nullity 
when directed against him. And when a receiver is appointed 
of the effects of a partnership in an action brought by a creditor 
of the firm, he cannot be garnisheed by judgment creditors of 
the firm as to partnership assets in his hands, such assets not 
being subject to garnishee process. 

Suits against Receivers 

\ 

The possession of the receiver being, as already shown, 
regarded as the exclusive possession of the court from which 
he derives his appointment, the courts are extremely averse 
to allowing any unauthorized interference therewith, and will 
not tolerate any attempt to disturb him in his rightful possession 
without leave of the court being first obtained for that purpose. 
A person who brings an action in one court against a receiver 
appointed by another court without the consent of the court 
whose officer such receiver is, is guilty of a contempt of the 
latter court. 

The proper practice in such case is for a person having a 
demand against the funds in the hands of the receiver to bring 
his demand in the court appointing the receiver and the court 
will direct him to be examined before a referee, and if, upon 
auditing his accounts, the court finds the claim to be a just 
one, it will direct the receiver to pay it without litigation. If, 
on the other hand, the court finds the claim to be a doubtful one, 
it will give the claimant leave to prosecute it against the receiver 
before some competent court. 

A state statute providing that all receivers appointed by 
any court may be sued without leave of the court appointing or 
controlling them, can have no application to receivers appointed 
by the federal courts. 

All books, documents, and papers in the hands of a receiver, 
however, are quasi-public in character, and are open to examina¬ 
tion by creditors. 


486 INSOLVENCY PROCEEDINGS 

Cases in Which a Receiver Will be Appointed 

There are four general classes of cases in which a court 
will appoint a receiver: 

1. Where there is no person competent by reason of in¬ 

terest, or otherwise, to take the custody and manage¬ 
ment of the property which constitutes the subject 
matter of litigation. 

2. Where, although all of the parties may be equally en¬ 

titled to possession and control of the property, still 
it is not proper that either of them should have pos¬ 
session or control of it. 

3. Where the person holding the property occupies a posi¬ 

tion of trust relation and is violating his fiduciary 
duties. 

4. Where after the rendition of a judgment or decree, the 

ordinary processes of the court cannot carry the 
judgment or decree into effect. 1 

To warrant the appointment of a receiver, it is essential 
that the plaintiff should show: (1) either a clear legal right 
in himself to the property, or that he has some lien on it, or that 
it constitutes some special fund out of which he is entitled 
to satisfaction of his demand; or (2) that possession of the 
property was obtained by the defendant through fraud, or that 
the property itself, or the income from it, is in danger of loss 
from the neglect, waste, misconduct, or insolvency of the 
defendant. 

Where the court is of the opinion that the plaintiff is en¬ 
titled to have a receiver appointed to take charge of the prop¬ 
erty in litigation, but feels that the plaintiff would be made 
secure in event of recovery by the furnishing of a bond by the 
defendant, it is within the discretion of the court to make 
an order refusing to appoint a receiver upon condition that the 
defendant furnish such a bond. 


1 Tardy’s Smith on Receivers, page 23. 



RECEIVERSHIP 


487 

In the absence of statute the mere insolvency of the defen¬ 
dant, without any other ground being stated as a cause of 
action, will not of itself be sufficient for the appointment of 
a receiver. Insolvency is, however, one of several reasons for 
appointing a receiver, but it is further predicated on the general 
doctrine of probable loss. Consequently, there must be coupled 
with an allegation of insolvency, additional allegations showing 
the plaintiff’s probable right of recovery and that such recovery 
will be lost or substantially jeopardized by reason of the 
insolvency unless a receiver is appointed. 2 The court will be 
influenced greatly by what in its opinion are considered the 
prospects of the plaintiff’s recovery. If the indications are 
clearly favorable, the risk of injury to the defendant is small, 
and the court will consequently not be so hesitant to interfere. 
A receiver may, however, be appointed in a proper case, not¬ 
withstanding that the defendant is perfectly solvent. 

An important principle in the application of this power is 
that the plaintiff is never entitled to a receiver when the equities 
of the case are fully denied by the sworn answer of the defen¬ 
dant, unless the evidence submitted in support of the bill is 
sufficient to overcome such denial. 

Receiver for a Partnership 

Where an application is made for a receiver in partnership 
cases, the situation with which the court is presented is this: 
If it grants the motion, the effect of it is to put an end to the 
partnership; whereas if it refuses the motion, it leaves the 
defendant at liberty to continue the partnership business at the 
risk and possibly irreparable loss of the complainant. In grant¬ 
ing the application, the court takes the affairs of the partnership 
out of the hands of all the partners and entrusts them to a 
receiver or manager of its own appointment. It excludes all 
the partners from taking any part in the management of the 
concern. 


2 Ibid., page 59. 



4 88 INSOLVENCY PROCEEDINGS 

Receiver for a Corporation 

The appointment of a receiver for a corporation has been 
likened to the remedy of “equitable execution,” whereby the 
court obtains absolute control of the corporate property. In 
most states the jurisdiction of the courts of equity over cor¬ 
porations has been extended by statute to the extent that 
receivers may be appointed to wind up the corporate affairs and 
to the forfeiture of its franchise. While these legislative 
enactments vary greatly in the different states, their general 
purpose and scope are to provide a more effectual method for 
the protection of creditors and stockholders. However, certain 
well-defined principles have been established. 

In the first place, in the absence of express statutory author¬ 
ity the jurisdiction of courts of equity does not extend to the 
power of corporate dissolution. The courts are therefore 
loath to sequestrate the effects of the corporation, or take the 
management of its affairs from the hands of its own officers 
and entrust it to the control of a receiver of the court upon 
the application of either creditors or stockholders. 

Where a statute authorizes the court upon application of 
any judgment creditor of a corporation, after execution re¬ 
turned unsatisfied, to sequestrate the property, stock, and 
choses in action of the corporation and to appoint a receiver, 
the statute will be strictly construed, since the exercise of this 
authority involves the virtual dissolution of the company, If, 
however, the corporation is insolvent and its directors have been 
guilty of fraudulent mismanagement of its affairs, a fit case is 
presented for a receiver in order to preserve the property for 
the benefit of its creditors and stockholders. 

The right of judgment creditors of a corporation to a 
sequestration of the corporate effects and to a receiver in aid 
of their judgments at law after execution returned unsatisfied, 
is a right which is given by statute in most states. It is in¬ 
consistent with the scope of this work to enter into a dis¬ 
cussion of these various statutes, but it may be stated as a 


RECEIVERSHIP 


489 

general proposition that a creditor of a corporation is not 
entitled to the aid of equity in the enforcement of his demand 
when he can obtain full and adequate relief at law. In the 
case of a corporation transacting a large business and where 
large interests are involved, the court may prevent interference 
by a judgment creditor seeking enforcement of his judgment 
by permitting the defendant to give security in lieu thereof. 

The primary object of receivership proceedings against in¬ 
solvent corporations being to preserve the assets for the benefit 
of creditors, the court will, as a rule, decline to appoint a re¬ 
ceiver, although the corporation is insolvent, if its directors, 
who are trustworthy persons, are clearing up its affairs and 
where the creditors and stockholders, except the complainant, 
are satisfied with the management of the directors. 

As regards the effect of appointing a receiver of an in¬ 
solvent corporation upon the rights of creditors, the decisions 
are not harmonious. As a rule, however, such appointment 
does not affect or impair a lien already acquired by the creditor 
upon assets of the corporation, and a creditor who has acquired 
a lien by attachment will be allowed to retain it, notwithstand¬ 
ing the subsequent proceedings. Nor does such appointment 
prevent the general creditors from enforcing their demands 
by suit when it does not appear that the appointment was made 

t 

with a view to a settlement but only to provide for the safety 
of the assets pending the litigation. 

When a receiver has been appointed under a statute author¬ 
izing receivers in case of insolvency, it is proper for the court 
to discharge him upon motion of the defendant corporation, 
upon its satisfying the court that it is in solvent circumstances 
and able to resume business, and that the best interests of 
the creditors will thereby be secured. 

Principles on Which the Relief Is Granted 

The first general principle is that a judgment creditor 
seeking the aid of the court by the appointment of a receiver 


490 


INSOLVENCY PROCEEDINGS 


must have used due diligence in the assertion of his rights. 
The bill must therefore be filed within a reasonable time after 
the execution has been returned unsatisfied. 

Another leading principle is that the plaintiff must have 
completely exhausted his remedy at law for the enforcement 
of his judgment. And when the bill itself shows that the 
defendant is in possession of property which is subject to levy 
and sale under execution, and that there is no obstacle in the 
way of enforcing the judgment by the usual process at law, no 
ground is presented for the appointment of a receiver. It 
therefore follows that the jurisdiction of equity will not be 
exercised in favor of mere general creditors whose rights rest 
only in contract and are not yet reduced to judgment, and who 
have acquired no lien on the property of the debtor. 

Fraudulent assignments of his property by a judgment 
debtor for the purpose of hindering and defeating his creditors, 
are frequently made the foundation of an application for a 
receiver in behalf of judgment creditors. Where it is shown 
that the judgment debtor has made such an assignment to an 
assignee who is known to be insolvent, such a breach of trust 
warrants the court in appointing a receiver of the property 
assigned. Especially will such relief be granted when the 
debtor himself continues in possession of the property. 

Functions of Receiver in Proceedings Supplementary to 

Execution 

The appointment of a receiver is also frequently resorted 
to as a means of assistance to judgment creditors after execu¬ 
tion has been returned unsatisfied, in two well-established lines 
of cases: 

i. Creditors^ Suits to Set Aside Fraudulent Convey¬ 
ances. The purpose of the suit in this class of cases is to 
have the impediment declared fraudulent and void as to the 
plaintiff and thus open up the way to the effective sale of 
the property under the law process. If there is in the hands 


RECEIVERSHIP 


491 


of an assignee a surplus over and above what is necessary to 
satisfy the claims of the creditors, the surplus may be reached 
by garnishment. 

2. Creditors’ Suits to Reach Assets Not Accessible 
under Legal Process. “The principle being established that 
every species of property belonging to a debtor may be reached 
and applied to the satisfaction of his debts, the powers of the 
court are perfectly adequate to carry that principle into full 
effect. The purpose of the courts in this second class of cases 
is to subject ‘equitable’ or non-executionable interests or assets 
of the debtor to the payment of creditors’ claims .” 3 

The function of a receiver when appointed in this class 
of cases is regarded as that of a trustee for the creditors only 
in whose behalf he was appointed, and, consequently, he can 
maintain his action only to the extent necessary to satisfy their 
judgments and no further. 

Since a receiver in proceedings supplementary to execution 
acquires title to the debtor’s property by virtue of his order of 
appointment, his title takes precedence over that of a judg¬ 
ment creditor who levies an execution subsequent to the 
receiver’s appointment. The receiver may therefore maintain 
an action to recover property so levied upon. 

The fact that the debtor has made an assignment for the 
benefit of creditors does not prevent a non-assenting creditor 
from maintaining an action to secure the satisfaction of his 
judgment. And when the receiver of a judgment debtor brings 
an action to set aside an assignment made by the debtor for the 
benefit of his creditors, it is proper for the court to permit 
the assignee to continue in possession and to liquidate the 
estate of the debtor. The assignees, under such circumstances, 
are regarded in the light of special receivers and bound to com¬ 
ply with such further orders pertaining to the proceeds as the 
court may make. This doctrine applies only when the receiver 


3 Tardy Smith on Receivers, pages 653-659. 



492 


INSOLVENCY PROCEEDINGS 


fails to show that the assignment was made to delay, hinder, 
or defraud creditors. 

Powers of Receiver 

The office of receiver is treated as one of confidence and 
trust, although his discretionary powers are limited. He is 
not an assignee of the estate over which he is appointed, being 
simply an officer of the court appointed to take charge of the 
property pending the litigation. If he is empowered to con¬ 
tinue the management of the business over which he is 
appointed, he may employ such persons as may be necessary for 
this purpose. 

The appointment of a receiver over property does not alter 
or affect the rights of the parties as regards the operation of 
the statute of limitations. A payment made by the receiver 
to one of the parties in the cause out of funds collected by him 
in his receivership, is not to be regarded as a payment made 
by the debtor to the extent of being an acknowledgment of 
the indebtedness so as to take the case out of the statute of 
limitations, since such payment is made by the receiver in his 
official capacity and as an officer of the court. 

A receiver being always regarded as an officer of the court 
and at all times subject to its direction and orders, it is proper 
in the discharge of his official duties that he should on suitable 
occasions apply to the court for instructions in advance; and 
he is at all times entitled to such advice from the court and 
should not hesitate to apply for it when questions of difficulty 
arise. When such an application is made notice should be 
given to all parties in interest. 

A receiver cannot purchase for his own benefit property 
connected with or forming a part of the subject matter of his 
receivership. The courts will not permit him, any more than 
any other trustee, to subject himself to the temptation arising 
from a conflict between the interest of a purchaser and the 
duty of a trustee. 


RECEIVERSHIP 


493 


Courts of equity are inclined to exercise a strict control 
over their receivers in the matter of allowing them to bring 
suits concerning the receivership, and an action brought by a 
receiver is considered as having been brought under the order 
of the court itself. The usual practice is for the receiver to 
apply to the court for leave to bring such actions before 
instituting suit. There is a conflict of authority as to whether, 
in the absence of statutory authority, a receiver may institute 
and conduct actions in his own name, or whether he must sue 
in the name of the original party in whose favor the action 
accrued. The weight of authority, however, seems to be that 
he must sue in the name of the party having the legal right. 

General Duties and Care Required of a Receiver 

The broad general duties of a receiver are to take charge 
of and safely keep and account for all property over which he 
is appointed receiver, and to obey all orders of the court having 
control of the receivership. Persons dealing with the receiver 
are therefore chargeable with notice of the fact that his powers 
are thus limited . 4 

Where parties to the record are directed by the order to 
deliver up to the receiver the possession of such parts of the 
property as are in their holding, the receiver as soon as his 
appointment is complete should apply to all such parties to 
deliver up possession accordingly. If possession is withheld 
from the receiver, an application is then made by motion and 
directed to the sheriff of the county wherein the property is 
situated, to put the receiver in possession in pursuance to the 
order. The “writ of assistance,” as it is called, is issued and 
executed in the same manner as the ordinary “writ of 
execution.” 

If the property is in the nature of a chose in action or debt, 
the receiver should give notice of such refusal to the court 
in order that the necessary steps may be taken to enforce the 


4 Tardy’s, Smith on Receivers, page 197* 



494 INSOLVENCY PROCEEDINGS 

court’s order, as the sanction of the court must be obtained 
to the receiver putting them in suit. 

Liabilities of a Receiver 

Before entering upon the performance of their duties, re¬ 
ceivers are usually required to execute a bond for the faithful 
performance of their duties, with adequate security, the amount 
and security for which is usually determined by the court with 
due regard to the value of the property to be entrusted to his 
care and management. 

A receiver is responsible for his acts directly to the court 
appointing him, and this responsibility continues until he is 
finally discharged. This immediate and direct responsibility 
to the court, however, does not relieve him from liabilities 
which he may incur toward third parties. Where a party 
to the cause, who is interested in the funds in the receiver’s 
hands, ascertains that the receiver has made improper payments, 
or has misapplied the funds or any portion of them, he may 
apply to the court for relief at any stage of the cause, and it 
is not necessary that he should wait until the receiver submits 
his accounts and then have the improper payment disallowed. 

The receiver being appointed for the benefit of all the 
parties in interest, and being an officer of the court, he is liable 
for any fraud or negligence of his own whereby injury accrues 
to the property entrusted to him. The liability of a receiver 
to the court appointing him does not terminate until his dis¬ 
charge. 

Salary and Compensation of a Receiver 

A receiver will, unless it is otherwise ordered, or unless he 
consents to act without a salary, be allowed a proper compensa¬ 
tion for the performance of the duties imposed upon him by 
law by virtue of the appointment. In the absence of statutory 
regulation, the matter of compensation is left entirely within 
the discretion of the court from which he derives his appoint- 


RECEIVERSHIP 


495 


ment, to be determined, in accordance with the circumstances 
of the particular case, and constitutes a part of the costs of the 
litigation. In many, if not most, jurisdictions there is no 
statute fixing the amount of the fee or compensation to be 
allowed a receiver. Where the fee is fixed by statute it 
usually consists of a certain percentage of the funds received 
and disbursed by the receiver. 

Receiver’s Accounts 

Receivers, being officers of the court appointing them, are 
required to account to the court for all receipts and disburse¬ 
ments in the course of their receivership, and courts of equity 
are disposed to hold receivers strictly accountable in rendering 
their accounts. A receiver will not ordinarily be permitted to 
make any expenditures which will seriously diminish the fund 
entrusted to his charge, without the sanction of the court, and 
it is his duty to apply to the court for instructions as to ex¬ 
penditures and to keep regular accounts of all items of receipts 
and expenditures, and must submit satisfactory vouchers 
against the fund entrusted to his keeping. 

A receiver cannot be compelled, pending litigation, to ac¬ 
count to a party to the suit, or to furnish him with statements 
showing the status of his accounts. He is only required to 
account to the court from which he derives his appointment, 
of which duty a party to the suit may avail himself by motion 
made to the court. 

When a receiver is charged with having allowed and paid, 
under order of the court, claims which are fictitious and un¬ 
founded, the proper practice for a creditor desiring to contest 
such allowances is to apply to the court to be made a party to 
the suit in which the order was made, and to have such order 
vacated. But once a receiver’s accounts have been approved 
by the court, they are only assailable by direct proceeding or 
petition calling attention to some error, fraud, or mistake in 
the accounts. 


496 INSOLVENCY PROCEEDINGS 

Removal and Discharge of Receivers 

The power of a court of equity to remove or discharge a 
receiver whom it has appointed may be regarded as well settled, 
and it may be exercised at any stage of the proceedings, the 
authority to call such officer into being necessarily implying: 
(i) the authority to terminate his functions when their exer¬ 
cise is no longer necessary, or (2) to remove the incumbent 
for an abuse of those functions. 

As regards the power of a court of equity to remove for 
cause and to substitute another in his stead, it is a matter 
properly resting in the discretion of the court and hence to be 
governed by the circumstances of each particular case. It is 
competent and not unusual for the court to remove one re¬ 
ceiver and appoint another by consent of all the parties when 
the proceedings are bona fide and when there is no attempt 
to traffic in the receivership. 

As regards the question of the final discharge of a receiver, 
as distinguished from his removal for cause, it may be laid 
down as a general proposition that when the necessity for the 
office has ceased to exist, the office itself must terminate and 
the receiver be discharged. In other words, the functions of a 
receiver usually terminate with the conclusion of the litiga¬ 
tion in which he was appointed. It is to be observed, how¬ 
ever, that the termination of the litigation does not discharge 
the receiver ipso facto, but in consequence of a formal order 
of the court. 

A receiver, being appointed in the interest of the parties 
to the action rather than his own, is not entitled to a dis¬ 
charge upon his own application, since the court will not 
permit the parties to be put to the expense and inconvenience 
of a change simply because the receiver desires to be relieved 
of his trust, but will be required to show some justifiable cause 
for the granting of his application. 

As regards the effect of the discharge of a receiver upon 
liabilities incurred by him during his receivership, it is held 


RECEIVERSHIP 


497 


that the discharge does not constitute a bar to bringing an 
action against him on account of such matters when the 
liability incurred is sufficient to create a cause of action. For 
example, when a receiver has taken possession of property be¬ 
longing to third persons, and has sold it under and by virtue 
of his receivership, and after notice of the rights claimed by 
such persons, the court will permit them to bring an action, 
notwithstanding his discharge, especially where they were not 
notified of the application for his discharge. 5 

5 For a more detailed and complete treatment of this subject consult High on Receivers, 
and also Tardy’s Smith on Receivers. 



CHAPTER XL 


BANKRUPTCY 

Bankruptcy Legislation 

In this connection the writer could suggest nothing more 
discouraging than a reading of the Bankruptcy Act, for rest 
assured it lacks a lot of reading like a novel. Nor is this sur¬ 
prising when it is remembered that the act was drafted with 
a view to being construed by trained legal minds rather than 
the average business man. And yet, as Remington, the well- 
recognized authority on bankruptcy, says, there never was a 
law less understood by the average citizen, and less appreciated 
by business men who are its chief beneficiaries. 

Fortunately, however, it is not necessary to make an 
exhaustive study of the entire act for a creditor to ascertain 
his rights and gain a general knowledge of the procedure 
through which the administration of a bankrupt’s estate passes, 
and only those sections with which every credit man should be 
familiar will be quoted and discussed in this chapter. 

A brief glance at its English origin and the subsequent 
development of bankruptcy legislation will suffice to show its 
intimate relationship to trade and commerce. 

The first bankruptcy act was passed during the reign of 
Henry VIII, and like the other early bankruptcy laws, was 
intended solely for the benefit of creditors. A bankrupt in 
those days was considered in much the same light as a quasi¬ 
criminal. The early laws did not provide that he should have 
the right to petition himself into bankruptcy and be relieved 
of his debts; they simply provided that under certain conditions 
his creditors could throw him into bankruptcy and divide what- 

498 


BANKRUPTCY 


499 


ever assets he possessed. As for the unpaid balance, he had to 
pay that as best he could, and in event he did not pay it, he 
went to jail. All of the early bankruptcy laws provided either 
imprisonment or the death penalty for the debtor. In fact, 
the death penalty for those who failed to pay their debts was 
common up to the nineteenth century. 

During the nineteenth century, however, the relation be¬ 
tween debtors and creditors underwent a decided change, due 
to the fact that the spirit of commercial interdependence had 
given rise to the idea that the grantor of credit is in a measure 
a partner of the debtor. In accordance with this development 
of a more humanitarian feeling toward insolvent debtors, later 
laws were passed to enable debtors who had surrendered all 
their property to escape imprisonment. Along toward the close 
of the nineteenth century, legislation was enacted which enabled 
honest debtors to obtain a discharge from the unpaid portion 
of their obligations. 

Turning now to the United States, we find that article i, 
section 8, of the United States Constitution provides: 

Congress shall have power to establish .... uniform laws 

on the subject of bankruptcy throughout the United States. 

Under the power thus granted, Congress has enacted four 
different bankruptcy statutes: one in 1800; one in 1841; one 
in 1867; and the statute of 1898, which continues in effect at 
the present time. 

Effect of a National Bankruptcy Law on State Insolvency 

Laws 

It is clearly established that when no national bankruptcy 
law is in force, the respective states possess full power to pass 
bankruptcy laws, and as Professor Williston has stated: “The 
only limitation at such a time on the power of the states is 
the constitutional prohibition against impairing the obligation 
of contracts.” He has further pointed out that: 


500 


INSOLVENCY PROCEEDINGS 


Owing to this prohibition, even though no national bank¬ 
ruptcy law isin force, a state cannot by a bankruptcy or insolvency 
law discharge a debt arising either from a contract entered into 
before the enactment of the state law in question, or under a 
contract made without the state. But the powers of the states, 
when congress has enacted a national bankruptcy law, are by 
no means so clear. It is indeed agreed, however, that the federal 
law is paramount and that the states must yield to its authority 
if collision arises. 

The most important question that arises in this connection 
relates to laws regulating general assignments for the benefit 
of creditors, and more particularly as to whether, upon assign¬ 
ing all his property for the benefit of his creditors, the debtor 
may be discharged from further liability for his debts then 
existing. 

That the right to make a general assignment for the benefit 
of creditors is not precluded by the passage of a Federal Bank¬ 
ruptcy Act, has been definitely established by the Supreme 
Court of the United States. 1 Such an assignment takes effect, 
not from any statute, but from the common law principles 
governing conveyances and trusts. If the owner of property 
may convey it to a trustee for one person, he may convey it 
to a trustee for any number of persons; that is, he may convey 
it to a trustee through an assignment for the benefit of all his 
creditors. 

Prior to the enactment of the Bankruptcy Act of 1898, 
most states had enacted legislation pertaining to the making 
of general assignments, and in some states the debtor making 
the assignment was discharged from further liability to credi¬ 
tors who actually proved their claims. A few states went still 
further and allowed the debtor a discharge from all provable 
claims. That so much of these statutes as related to the debtor’s 
discharge is suspended by the federal act is well settled. How¬ 
ever, it has also been decided by the Supreme Court that the 


1 91 U. S. 496. 



BANKRUPTCY 


501 

suspension of this portion of the statute does not necessarily 
invalidate the statute itself. 2 

Purpose of Bankruptcy Legislation 

“What is the purpose of a bankruptcy law?” asked the 
Attorney-General of England in introducing the English Bill 
of 1869. “The object,” he answered, “is to collect the pro¬ 
ceeds of estates of bankrupts and to distribute them among the 
creditors as fairly, cheaply, and speedily as possible.” 

In America, unfortunately, bankruptcy has come to be 
regarded as a sort of poor debtor’s law, as a sort of clearing 
house for the liquidation of debt, whereby certain debtors at 
intermittent periods receive emancipation, are rehabilitated, and 
the “dead wood” of the community is thereby eliminated. 

When the question of bankruptcy legislation was first con¬ 
sidered in Congress, one ardent champion of bankruptcy 
legislation argued that: 

The necessity of a bankruptcy law results wherever a nation 
is in any considerable degree commercial. No commercial 
people can be well governed or exist without it. Its necessity 
arises from the nature of trade and is founded on the principle 
that commerce is built on great credits, and great credits produce 
great debts. Owing to the risks arising from these and other 
circumstances, the most diligent and honorable merchant may 
be ruined without committing any fault. These circumstances 
make a bankrupt law necessary to the merchants. 

The purpose of our present-day bankruptcy proceedings is 
not only to effect a distribution of the bankrupt’s assets equi¬ 
tably among the creditors, but to also discharge those taking 
advantage of the law from the burden of their obligations, 
even though the assets are insufficient to pay all claims, leaving 
no balances to be paid once a discharge is granted, the theory 
being that it is more expedient from a social standpoint to 
relieve an honest debtor of the load of debt which makes him 


2 108 u. s. 379. 



5°2 


INSOLVENCY PROCEEDINGS 


a drone and to save him from going to either an asylum or 
an almshouse. This does not mean, however, that the debtor 
is no longer indebted to his creditors, for the moral obligation 
continues, but rather that it is deemed to be for the best inter¬ 
ests of social and business welfare to protect a man under 
such circumstances, to such an extent as to relieve him from the 
pressure of his creditors—analogous in effect to the Statute of 
Limitations as applied to other debts. 

1. Suppose you hold A’s promissory note for $500, but for 
some reason you delay suing him for payment of the note 
for ten years. Under the Statute of Limitations you can no 
longer sue A—you have “slept on your rights” too long. The 
Statute does not say that A no longer owes you $500, for if the 
debt was good when incurred, the personal obligation continues 
until satisfied; it merely says that the court will not countenance 
such old claims, and your only recourse lies in an appeal to the 
debtor’s moral sense of obligation. 

2. Suppose A is indebted to you to the extent of $500 at the 
time he goes into bankruptcy. The Bankruptcy Act provides 
that upon turning over all of his property for the benefit of his 
creditors the bankrupt may be discharged from further legal 
liability for his existing debts. It does not say that A no longer 
owes you the unpaid balance on your claim. It merely says 
that A can no longer be held legally liable for the unpaid balance, 
and, again, your only recourse lies in an appeal to the debtor’s 
moral sense of obligation. Nor is it uncommon for a bankrupt 
to recognize the unpaid portion of such claims as still existing 
debts of honor and to pay off such unpaid balances even after 
receiving a discharge in bankruptcy. The commercial integrity 
of such a man is thereafter firmly established in the community 
and entitles him to credit above others who are of equal financial 
strength. 

Nature of the Proceedings 

To accomplish its purpose the act provides for: 

1. Taking possession of the assets of the insolvent debtor, 
either upon his own request or that of the creditors, 
when justified. 


BANKRUPTCY 


503 

2. The investigation of any apparent irregularities in the 

conduct of the business. 

3. The sale of the assets and distribution of the proceeds 

among the creditors. 

4. Granting him, in the absence of fraud, a discharge from 

the unpaid balance of his debts. 

The various steps incidental to the administration of a 
bankrupt’s estate may be stated briefly as follows: 

1. Petition is filed, together with a schedule of the assets 

and liabilities, in the federal district court. 

2. Court adjudges the petitioner a bankrupt and refers the 

case to the referee for administration. 

3. The referee notifies the creditors of the adjudication. 

4. Creditors file proofs of debts, covering their claims with 

the referee. 

5. Meeting of the creditors is called by the referee. 

6. Creditors elect a trustee to handle the estate under 

supervision of the referee. 

7. Examination of the bankrupt by the creditors. 

8. Trustee winds up the estate and prorates the assets 

among the creditors. 

9. Trustee submits a final report to the referee for ap¬ 

proval. 

10. If approved, the report is submitted to the court, by 

whom the discharge is granted. 

Voluntary and Involuntary Bankruptcy 

Before proceeding further with the discussion it might be 
well to point out the difference between what is termed u volun¬ 
tary” and “involuntary” bankruptcy. Fundamentally, the dis¬ 
tinction is simply this: In the former instance the debtor 
himself requests of the court that he be adjudged a bankrupt, 
whereas in the latter he is forced into bankruptcy by his 
creditors against his will. 

The act provides that anyone, regardless of the amount 


504 


INSOLVENCY PROCEEDINGS 


owing, may file a petition in bankruptcy, with four excep¬ 
tions : banking, insurance, railroad, and municipal corporations. 

* 

These are excepted on grounds of public policy for obvious 
reasons. In event of any of these institutions becoming 
insolvent, creditors can apply to a court of equity for the 
appointment of a receiver to take charge of the assets on behalf 
of the creditors. 

Although it is immaterial how small may be the amount 
the person may owe when he makes his application to be 
adjudged a bankrupt, the expense of the proceedings affords 
an effectual bar to small debtors taking advantage of the privi¬ 
lege, and it is not usual for anyone to make a voluntary appli¬ 
cation unless he is insolvent and being harrassed by his 
creditors. Under such circumstances, however, it is some¬ 
times better for the debtor to anticipate the inevitable and end 
the unavailing struggle by requesting the court to adjudge him 
a bankrupt. 

There are two ways in which creditors can close a bank¬ 
rupt’s business and force an application of his property to the 
payment of their claims. The first is to bring a suit in equity 
to have a receiver appointed, who then takes charge of the 
business, sells the property, and divides the proceeds among 
the creditors under the direction of the court. The difficulty 
with the proceedings in equity is that if any of the other credi¬ 
tors start proceedings in bankruptcy, the equity proceeding 
fails and all creditors must come in under the bankruptcy 
proceedings. The second way is to institute bankruptcy pro¬ 
ceedings in the federal district court. 

Acts of Bankruptcy 

It is only under certain conditions, however, that anyone 
may be forced into involuntary bankruptcy by his creditors. 
He must not be a wage-earner (one whose compensation does 
not exceed $1,500 a year), or a farmer. It must also be proved 
that the debtor: (1) owes at least $1,000, (2) has been a 


BANKRUPTCY 


505 


resident of the judicial district in which the petition is filed 
over three months, and (3) has committed one of the five acts 
of bankruptcy. The act provides that a petition may be filed 
against a person who is insolvent and who has committed an 
act of bankruptcy within four months after the commission 
of such act. 

The five acts of bankruptcy set forth in Chapter III, 
section 3, paragraph (b) consist of the following: 

1. Having conveyed, transferred, concealed or removed or per¬ 

mitted to be concealed or removed any part of his property 
with intent to hinder, delay, or defraud his creditors, or any 
of them; or 

2. Transferred, while insolvent, any portion of his property to one 

or more of his creditors with intent to prefer such creditors 
over his other creditors; or 

3. Suffered or permitted, while insolvent, any creditor to obtain 

a preference through legal proceedings, and not having at 
least five days before a sale or final disposition of any prop¬ 
erty affected by such preference vacated or discharged such 
preference; or 

4. Made a general assignment for the benefit of his creditors, or, 

being insolvent, applied for a receiver or trustee for his 
property or because of insolvency a receiver or trustee has 
been put in charge of his property under the laws of a 
State, of a Territory, or of the United States; or 

5. Admitted in writing his inability to pay his debts and his 

willingness to be adjudged a bankrupt on that ground. 

In such instances Chapter VI, section 59, paragraph (c) 
provides: 

Petitions shall be filed in duplicate, one copy for the clerk 
and one for service on the bankrupt. 

and Chapter III, section 3, paragraph (e) : 

Whenever a petition is filed by any person for the purpose 
of having another adjudged a bankrupt, and an application is 
made to take charge of and hold the property of the alleged 
bankrupt, or any part of the same prior to the adjudication and 
pending a hearing on the petition, the petitioner or applicant 


INSOLVENCY PROCEEDINGS 



shall file in the same court a bond with at least two good and 
sufficient sureties who shall reside within the jurisdiction of said 
court, to be approved by the court or a judge thereof, in such 
sum as the court shall direct, conditioned for the payment, in 
case such petition is dismissed, to the respondent, his or her 
personal representatives, of all costs, expenses and damages 
occasioned by such seizure, taking, and detention of the property 
of the alleged bankrupt. 

Proceedings in Bankruptcy 

In both voluntary and involuntary bankruptcy the proceed¬ 
ings are begun by the filing of the petition. But in the case 
of involuntary bankruptcy proceedings especially, it is not 
unusual for the petition to request the appointment of a receiver 
to protect the property until a trustee is elected. If the bank¬ 
rupt in such instances elects to contest the proceedings, a jury 
trial is necessary before the court can pronounce him a bank¬ 
rupt. Usually such suits are not contested, and at the expira¬ 
tion of the 20 days which the bankrupt is given in which to 
reply, the court enters a decree adjudging him a bankrupt. 
No one is technically a bankrupt until he has been adjudged 
a bankrupt by a court upon which the legislature has conferred 
bankruptcy jurisdiction. 

However, once adjudged a bankrupt, the administration of 
the estate is practically the same in both instances. 

For administrative purposes, each state is divided into what 
are known as judicial districts and each district subdivided into 
two or more divisions, each comprising so many counties, etc. 
Proceedings are carried on under the general supervision of 
the judges of the United States federal court, and usually in 
the federal building of the most important city in the division. 

The petition is made out on a prescribed legal form 
providing for: 

1. Statement of the creditors to be paid in full, to v/hom 

priority is secured by law. 

2. Statement of creditors holding security. 


BANKRUPTCY 


507 


3. Statement of unsecured claims. 

4. Statement of liabilities. 

5. Statement of assets, in which is listed: 

(a) Realty 

(b) Personalty 

(c) Choses in action 

(d) Property held in trust 

6. Statement of property claimed as exempt. 

7. Oath in verification as to truthfulness of the statement. 

With reference to exemptions the law provides in Chapter 
III, section 6: 

This act shall not affect the allowance to bankrupts of the 
exemptions which are prescribed by the State laws in force at 
the time of the filing of the petition in the State wherein they have 
had their domicile for the six months or the greater portion 
thereof immediately preceding the filing of the petition. 

The prepared petition is then filed with the clerk of the 
district court in which the bankrupt resides, for which a fee 
of $30 is prescribed, $15 of which goes to the referee, $10 
to the clerk, and $5 to the trustee. As to who may file the 
petition, Chapter VI, section 59, paragraphs (a) and (b) 
provide: 

Any qualified person may file a petition to be adjudged a vol¬ 
untary bankrupt. 

Three or more creditors who have provable claims against any 
person which amount in the aggregate in excess of the value of 
securities held by them, if any, to five hundred dollars or over; 
or if all of the creditors of such person are less than twelve in 
number, then one of such creditors whose claim equals such 
amount may file a petition to have him adjudged a bankrupt. 

The clerk having made the necessary entries, the petition 
is submitted to the court, who, upon approving it, adjudges the 
petitioner a bankrupt (after the expiration of the 20 days) 
and directs the referee to proceed with the administration of 
the estate; or in event of an involuntary petition being filed, 


INSOLVENCY PROCEEDINGS 


508 

directs the clerk to issue a subpoena, which is served by an 
officer of the court. 

Referee in Bankruptcy 

The referee is an officer of the federal court, appointed by 
the district judge for a period of two years, to supervise the 
administration of bankrupt estates within an assigned terri¬ 
tory. His duties begin just as soon as the insolvent has been 
adjudged a bankrupt, and continue up to the time a discharge 
is granted. All proceedings incidental to winding up a bank¬ 
rupt’s estate take place before the referee acting in the capacity 
of “judge in bankruptcy.” His first duty is to notify every 
creditor of the adjudication and call a creditors’ meeting for 
the purpose of electing a trustee, the time for which is provided 
for in Chapter VI, section 55, as follows: 

The court shall cause the first meeting of the creditors of a 
bankrupt to be held, not less than ten nor more than thirty days 
after the adjudication, at the county seat of the county in which 
the bankrupt has had his principal place of business, resided, or 
had his domicile; or if that place would be manifestly incon¬ 
venient as a place of meeting for the parties in interest, the 
court shall fix a place for the meeting which is the most convenient 
for parties in interest. 

At the first meeting of creditors the judge or referee shall 
preside, and, before proceeding with the other business, may 
allow or disallow the claims of creditors there presented, and 
may publicly examine the bankrupt or cause him to be examined 
at the instance of any creditor. 

The creditors shall at each meeting take such steps as may be 
pertinent and necessary for the promotion of the best interests 
of the estate and the enforcement of this act. 

The jurisdiction of the referees is defined in Chapter V, 
section 38, as follows: 

Referees respectively are hereby invested, subject always to 
a review by the judge, within the limits of their districts as 
established from time to time, with jurisdiction to (1) consider 
all petitions referred to them by the clerks and make the adjudi- 


BANKRUPTCY 


509 


cations or dismiss the petitions; (2) exercise the powers vested 
in courts of bankruptcy for the administering of oaths to and 
the examination of persons as witnesses and for requiring the 
production of documents in proceedings before them, except the 
power of commitment; (3) exercise the powers of the judge for 
the taking possession and releasing of the property of the bank¬ 
rupt in the event of the issuance by the clerk of a certificate show¬ 
ing the absence of a judge from the judicial district, or the division 
of the district, or his sickness, or inability to act; (4) perform such 
part of the duties except as to questions arising out of the appli¬ 
cations of bankrupts for compositions or discharges, as are by 
this act conferred on courts of bankruptcy and as shall be pre¬ 
scribed by rules or orders of the courts of bankruptcy of their 
respective districts, except as herein otherwise provided; and 
(5) upon the application of the trustee during the examination 
of the bankrupts, or other proceedings, authorize the employ¬ 
ment of stenographers at the expense of the estates at a compen¬ 
sation not to exceed ten cents per folio for reporting and tran¬ 
scribing the proceedings. 

The duties of the referees are prescribed in Chapter V, 
section 39, as follows: 

Referees shall (1) declare dividends and prepare and deliver 
to trustees dividend sheets showing the dividends declared and 
to whom payable; (2) examine all schedules of property and list 
of creditors filed by bankrupts and cause such as are incomplete 
or defective to be amended; (3) furnish such information con¬ 
cerning the estates in process of administration before them as 
may be requested by the parties in interest; (4) give notices to 
creditors as herein provided; (5) make up records embodying the 
evidence, or the substance thereof, as agreed upon by the parties 
in all contested matters arising before them, whenever requested 
to do so by either of the parties thereto, together with their 
findings therein, and transmit them to the judges; (6) prepare 
and file the schedules of property and lists of creditors required 
to be filed by the bankrupts, or cause the same to be done, 
when the bankrupts fail, refuse, or neglect to do so. 

The Trustee 

A trustee is the one elected by the creditors to take charge 
of a bankrupt estate, a majority in both number and amount 


5 io INSOLVENCY PROCEEDINGS 

of provable claims being necessary to effect such an election. 
Creditors holding some security for their claims are not allowed 
to vote in the proceedings, so far as those claims are concerned, 
unless the security is insufficient to cover the entire claim. In 
the latter case they may vote the amount of the claim over and 
above the value of the security. Just as the referee represents 
the court, we have the trustee representing the creditors. This 
places the administration of a bankrupt estate entirely in the 
hands of the creditors, acting through the medium of their 
trustee. In event the creditors cannot agree on a trustee, the 
referee appoints one—the selection always being subject to 
ratification by the court. 

The duties of a trustee are outlined in Chapter V, section 
47, paragraph (a), as follows: 

Trustees shall respectively (i) account for and pay over to 
the estates under their control all interest received by them 
upon property of such estates; (2) collect and reduce to money 
the property of the estates for which they are trustees, under 
the direction of the court, and close up the estate as expeditiously 
as is compatible with the best interests of the parties in interest; 
and such trustees, as to all property in the custody or coming 
into the custody of the bankruptcy court, shall be deemed vested 
with all the rights, remedies, and powers of a creditor holding a 
lien by legal or equitable proceedings thereon; and also, as to all 
property not in the custody of the bankruptcy court, shall be 
deemed vested with all the rights, remedies, and powers of a 
judgment creditor holding an execution duly returned unsatis¬ 
fied; (3) deposit all money received by them in one of the desig¬ 
nated depositories; (4) disburse money only by check or draft 
on the depositories in which it has been deposited; (5) furnish such 
information concerning the estates of which they are trustees 
and their administration as may be requested by parties in 
interest; (6) keep regular accounts showing all amounts received 
and from what sources and all amounts expended and on what 
accounts; (7) lay before the final meeting of the creditors detailed 
statements of the administration of the estate; (8) make final 
reports and file final accounts with the courts fifteen days before 
the days fixed for the final meetings of the creditors; (9) pay 


BANKRUPTCY 


dividends within ten days after they are declared by the referees; 

. money on hand, and such other details as may be 
required by the courts, within the first month after their 
appointment and every two months thereafter, unless otherwise 
ordered by the courts; and (n) set apart the bankrupt’s exemp¬ 
tions and report the items and estimated value thereof to the 
court as soon as practicable after their appointment. 

It is quite apparent what an important personage a trustee 
is, for upon qualifying for the position by filing a bond, the 
amount of which is determined by the creditors in accordance 
with Chapter V, section 50, paragraph (c) : 

The creditors of a bankrupt estate, at their first meeting after 
the adjudication, or after a vacancy has occurred in the office of 
trustee, .... shall fix the amount of the bond of the trustee ; 
they may at any time increase the amount of the bond. 

He becomes vested with the title to all property of the bankrupt, 
by virtue of Chapter VII, section 70, which is as follows: 

The trustee of the estate of a bankrupt, upon his appointment 
and qualification, and his successor or successors, if he shall have 
one or more, upon his or their appointment and qualification 
shall in turn be vested by operation of law with the title of the 
bankrupt, as of the date he was adjudged a bankrupt, except in 
so far as it is to property which is exempt, to all (1) documents 
relating to his property; (2) interests in patents, patent rights, 
copyrights, and trade-marks; (3) powers which he might have 
exercised for his own benefit, but not those which he might have 
exercised for some other person; (4) property transferred by him 
in fraud of his creditors; (5) property which prior to the filing 
of the petition he could by any means have transferred or 
which might have been levied upon and sold under judicial 
process against him: Provided, That when any bankrupt shall 
have any insurance policy which has a cash surrender value 
payable to himself, his estate, or personal representatives, he may, 
within thirty days after the cash surrender value has been ascer¬ 
tained and stated to the trustee by the company issuing the 
same, pay or secure to the trustee the sum so ascertained and 
stated, and continue to hold, own, and carry such policy free from 
the claims of the creditors participating in the distribution of 
his estate under the bankruptcy proceedings, otherwise the 


5 12 


INSOLVENCY PROCEEDINGS 


policy shall pass to the trustee as assets; and (6) rights of action 
arising upon contracts or from the unlawful taking or detention 
of, or injury to, his property. 

All real and personal property belonging to bankrupt estates 
shall be appraised by three disinterested appraisers; they shall 
be appointed by, and report to, the court. Real and personal 
property shall, when practicable, be sold subject to the approval 
of the court; it shall not be sold otherwise than subject to the 
approval of the court for less than seventy-five per centum of its 
appraised value. 

The title to property of a bankrupt estate which has been 
sold, as herein provided, shall be conveyed to the purchaser by 
the trustee. 

The trustee proceeds to dispose of the bankrupt estate to 
the greatest advantage and best interests of all the creditors. 
Compensation for his efforts is regulated by the law itself on 
a percentage basis, and is not sufficiently large to make the 
office very attractive. It is 6 per cent on the first $500, 4 per 
cent on that from $500 to $1,500, 2 per cent on that from 
$1,500 to $10,000, and 1 per cent on all above $10,000. 

Filing of Claims 

The importance of creditors filing their claims promptly 
upon receipt of notice of the adjudication or the first creditors’ 
meeting is obvious when it is remembered that none but credi¬ 
tors with allowed claims can participate in the selection of a 
trustee. 

There is a prescribed bankruptcy form, the “proof of 
debt” (Form 28a), for the use of creditors in filing their 
claims, so drawn as to comply with Chapter VI, section 57, 
paragraph (a) : 

Proof of claims shall consist of a statement under oath, in 
writing, signed by a creditor setting forth the claim, the con¬ 
sideration therefor, and whether any, and, if so, what securities 
are held therefor, and whether any, and if so, what payments 
have been made thereon, and that the sum claimed is justly 
owing from the bankrupt to the creditor. 


BANKRUPTCY 


513 


Proof of Debt Due Corporation 
In The District Court of the United States, 

For the . . Southern.. District of . . Ohio.. 


.. The Union Leather Company. . 
. Cincinnati , Ohio . 


IN BANKRUPTCY, No, 


At .. Cincinnati . ., in said .. Southern. . district of . . Ohio .., on the .. nine¬ 
teenth .. day of . .August . ., A. D. . . 19 —. ., came .. William J. Schawe.. of 
.. Cincinnati . ., in the county of . . Hamilton. ., and State of . . Ohio. ., and 
made oath, and says that he is . . Treasurer. . (1) of the . . The Durr ell-Schawe 
Manufacturing Co. . a corporation incorporated by and under the laws of the 
State of . . Ohio. . and carrying on business at . . Cincinnati . ., in the county 
of . . Hamilton. ., and State of . . Ohio. ., and that he is duly authorized to 
make this proof, and says that the said . . . The Union Leather Company . . .the 
person by [or, against] whom a petition for adjudication of bankruptcy has been 
filed, was at and before the filing of said petition, and still is justly and truly 
indebted to said corporation in the sum of . . Ninety-five and 46/100. . dollars; 
that the consideration of said debt is as follows: . . merchandise sold and deliv¬ 
ered on open account by said claimant to said debtor, at its special instance and 
request, as per statement attached. . that no part of said debt has been paid, 


except . that there are no set-offs or counterclaims to 

the same, except . and that said corporation has not, 


nor has any person by its order, or to the knowledge or belief of said deponent, 
for its use, had or received any manner of security for said debt whatever, 
or any note for such account; nor has any judgment been rendered thereon.(3) 

. Wm. J. Schawe . 

. . Treasurer. . (1) of said Corporation. 

Subscribed and sworn to before me this . .nineteenth .. day of . .August.., 
A. D. .. 19 —.. 

. Howard D. Merry . 

.. Notary Public—Hamilton County, Ohio .. (2) 
My commission expires Oct. 23, 19 — 


(1) . This deposition must be made by the treasurer, or, if the corporation has no treasurer, by 
the officer whose duties most nearly correspond to those of treasurer. 

(2) . Signature and official character of officer. This may be acknowledged before a referee, or 
a United States commissioner, or a notary public. 

(3) . See Gen. Ord. 21. 


Form 28. (a) Proof of Debt Filed in Bankruptcy Proceedings 


A blank power of attorney is incorporated in the “proof of 
debt” (Form 28b), in event the creditor is unable to be present 
himself and wishes to be represented by an attorney. A gen¬ 
eral letter of attorney in fact (Form 29) may be used after a 
creditor has once filed his claim. 

Proof of claims is denied all creditors, as a rule, after one 
year from the adjudication, Chapter VI, section 57, paragraph 
(n), providing: 

Claims shall not be proved against a bankrupt estate sub¬ 
sequent to one year after the adjudication; or if they are 
















5M 


INSOLVENCY PROCEEDINGS 


In the District Court of the United States 
For the .. Southern. . District of .. Ohio.. 

.. The Union Leather Company.. \ IN BANKRUPTCY 
. Cincinnati, Ohio ./ No. 

To . .Brown, Bussey & Williams—Attorneys at Law.. 

. . Cincinnati, Ohio.. 

I .. William J. Schawe .., of .. Cincinnati.. in the county of .. Hamil¬ 
ton .., and State of .. Ohio .., do hereby authorize you, or any one of you, to 
attend the meeting or meetings of creditors of the bankrupt aforesaid at a 
court of bankruptcy, wherever advertised or directed to be holden, on the 
day and at the hour appointed and notified by said court in said matter, or 
at such other place and time as may be appointed by the court for holding 
such meeting or meetings, or at which such meeting or meetings, or any ad¬ 
journment or adjournments thereof may be held, and then and there from 
time to time, and as often as there may be occasion, for me and in my name 
to vote for or against any proposal or resolution that may be then submitted 
under the acts of Congress relating to Bankruptcy; and in the choice of trus¬ 
tee or trustees of the estate of the said bankrupt, and for me to assent to 
such appointment of trustee; and with like powers to attend and vote at 
any other meeting or meetings of creditors, or sitting or sittings of the court, 
which may be held therein for any of the purposes aforesaid; also to accept 
any composition proposed by said bankrupt in satisfaction of his debts, and 
to receive payments of dividends and of money due me under any composi¬ 
tion, and for any other purpose in my interest whatsoever, with full power of 
substitution. 

In Witness Whereof, I have hereunto signed my name and affixed my seal 
the . .ig .. day of .. A ugust .. A. D. .. ig —.. 

.. Wm. J. Schawe . 

Signed, sealed and delivered in presence of 
. . (signature of witness). . 

Acknowledged before me this ..nineteenth., day of ..August.. A. D. 

.. 19—.. 

. Howard D. Merry . 

.. Notary Public—Hamilton County, Ohio .. (1) 
My commission expires Oct. 23, ig — 


The State of . . Ohio. ., County of . . Hamilton. ., ss: 

. . William J. Schawe. ., being first duly sworn, says that he is . . Treasurer of 
The Durr ell-Schawe Manufacturing Co... and that he is duly authorized to 
execute the foregoing power of attorney. 

. Wm. J. Schawe . 

Sworn to and subscribed before me this . .nineteenth.. day of . .August,.. 
A. *D. 19—.. 

. Howard D. Merry . 

... Notary Public—Hamilton County, Ohio . .. 
My commission expires Oct. 23, ig — 


, , Signature and official character of officer. This may be proved or acknowledged before a 

referee, or a United States C ommissioner or a notary public. When executed on behalf of a partner¬ 
ship or of a corporation the person executing the instrument shall make oath that he is a member of 
the partnership, or a duly authorized officer of the corporation on whose behalf he acts. When the 

sh all* be es t a y tl sffictor y °p rooh ° ^ taking the Pr °° f ° r acknowled g m ent, his identity 


Form 28. (b) Power of Attorney (Reverse of Proof of Debt) 












BANKRUPTCY 


515 


General LettfLr of Attorney in Fact when Creditor is NOt Represented 

by Attorney at Law 


In the District Court of the United States, 

For the .. Southern.. District of .. Ohio.. 


.. The Union Leather Company.. 
. Cincinnati, Ohio. ...... 


IN BANKRUPTCY, No. 


To .. Vaughn E. Montgomery.. 

.. Cincinnati, Ohio.. 

I, ..William J. Schawe.., of ..Cincinnati., in the county of ..Hamil¬ 
ton . ., and State of . . Ohio . ., do hereby authorize you, or any one of you, to 
attend the meeting or meetings of creditors of the bankrupt aforesaid at a 
court of bankruptcy, wherever advertised or directed to be holden, on the 
day and at the hour appointed and notified by said court in said matter, or 
at such other place and time as may be appointed by the court for holding 
such meeting or meetings, or at which such meeting or meetings, or any ad¬ 
journment or adjournments thereof may be held, and then and there from 
time to time, and as often as there may be occasion, for me and in my name 
to vote for or against any proposal or resolution that may be then submitted 
under the acts of Congress relating to Bankruptcy; and in the choice of trustee 
or trustees of the estate of the said bankrupt, and for me to assent to such 
appointment of trustee; and with like powers to attend and vote at any other 
meeting or meetings of creditors, or sitting or sittings of the court, which 
may be held therein for any of the purposes aforesaid; also to accept any 
composition proposed by said bankrupt in satisfaction of his debts, and to 
receive payment of dividends and of money due me under any composition, 
and for any other purpose in my interest whatsoever, with full power of 
substitution. 

In witness whereof, I have hereunto signed my name and affixed my seal 
the . .19th.. day of . .August. ., A. D. 19 . .—. . 

. Wm. J. Schawe . [Seal] 

Signed, sealed, and delivered in presence of 


Acknowledged before me this . .19th. . day of . .August. ., A. D. 19—.. 

. Wm. J. Schawe . 

. . Treasurer of The Durr ell-Schawe Manufacturing Co.( 1) 
The State of . . Ohio. ., County of .. Hamilton. ., ss: 

. .William J. Schawe. ., being first duly sworn, says that he is . .Treasurer 
of The Durr ell-Schawe Manufacturing Co.. ., and that he is duly authorized 
to execute the foregoing power of attorney. 

. Wm. J. Schawe . 

Sworn to and subscribed before me this ..19th.. day of ..August.., 
A. D. 19—.. 

. Howard D. Merry . 

My commission expires Oct. 23, 19 —.. 

... Notary Public—Hamilton County, Ohio. .. 

(I). Signature and official character of officer. This may be proved or acknowledged before a 
referee, or a United States Commissioner, or a notary public. When executed on behalf of a partner- 
ship or of a corporation, the person executing the instrument shall make oath that he is a member of 
the partnership, or a duly authorized officer of the corporation on whose behalf he acts, when the 
person executing is not personally known to the officer taking the proof or acknowledgment, his identity 
shall be established by satisfactory proof. 

Form 29. General Letter of Attorney in Fact 

















INSOLVENCY PROCEEDINGS 



liquidated by litigation and the final judgment therein is rendered 
within thirty days before or after the expiration of such time, 
then within sixty days after the rendition of such judgment. 

Meetings of Creditors 

It is generally at the first creditors’ meeting and after a 
trustee has been selected, that the bankrupt is sworn by the 
court and placed on the witness stand, it being a privilege of 
the creditors to examine him personally or through their 
attorneys. Subsequent meetings may be called for conference 
in regard to disposition of the estate, as provided for in Chap¬ 
ter VI, section 55, paragraphs (e) and (f) : 

The court shall call a meeting of creditors whenever one- 
fourth or more in number of those who have proven their claims 
shall file a written request to that effect; if such request is signed 
by a majority of such creditors, which number represents a ma¬ 
jority in amount of such claims, and contains a request for such 
meeting to be held at a designated place, the court shall call such 
meeting at such place within thirty days after the date of the 
filing of the request. 

Whenever the affairs of the estate are ready to be closed 
a final meeting of creditors shall be ordered. 

provided the creditors are notified as stipulated in Chapter VI, 
section 58, paragraphs (a) and (c) : 

Creditors shall have at least ten days’ notice by mail, to 
their respective addresses as they appear in the list of creditors 
of the bankrupt, or as afterwards filed with the papers in the case 
by the creditors, unless they waive notice in writing, of (1) all 
examinations of the bankrupt; (2) all hearings upon application 
for the confirmation of compositions; (3) all meetings of 
creditors; (4) all proposed sales of property; (5) the declaration 
and time of payment of dividends; (6) the filing of the final 
accounts of the trustee, and the time when and the place where 
they will be examined and passed upon; (7) the proposed com¬ 
promise of any controversy; (8) the proposed dismissal of the 
proceedings; and (9) there shall be thirty days’ notice of all 
applications for the discharge of bankrupts. 

All notices shall be given by the referee, unless otherwise 
ordered by the judge. 


BANKRUPTCY 


517 


Examination of the Bankrupt 

This is oftentimes a most important phase of the proceed¬ 
ings, especially when suspicion attaches to the disposition of 
certain property of the bankrupt, for under such circumstances 
it is incumbent upon the creditors to establish the fraud or 
preference, and it is primarily to enable and assist them in 
making out their case that this privilege is extended in Chapter 
III, section 7, paragraph (a) : 

The bankrupt shall (1) attend the first meeting of his creditors 
if directed by the court or a judge thereof to do so, and the hearing 
upon his application for a discharge, if filed; (2) comply with all 
lawful orders of the court; (3) examine the correctness of all 
proofs of claims filed against his estate; (4) execute and deliver 
such papers as shall be ordered by the court; (5) execute to his 
trustee transfers of all his property in foreign countries; (6) 
immediately inform his trustee of any attempt, by his creditors 
or other persons, to evade the provisions of this act, coming 
to his knowledge; (7) in case of any person having to his knowl¬ 
edge proved a false claim against his estate, disclose that fact im¬ 
mediately to his trustee; (8) prepare, make oath to, and file in 
court within ten days, unless further time is granted, after 
the adjudication, if an involuntary bankrupt, and with the 
petition if a voluntary bankrupt, a schedule of his property, 
showing the amount and kind of property, the location thereof, 
its money value in detail, and a list of his creditors showing 
their residences .... the amounts due each of them, all 
in triplicate, one copy of each for the clerk, one for the referee, 
and one for the trustee; and (9) when present at the first meeting 
of his creditors, and at such other times as the court shall 
order, submit to an examination concerning the conducting of his 
business, the cause of his bankruptcy, his dealings with his 
creditors and other persons, the amount, kind, and whereabouts 
of his property, and in addition, all matters which may affect 
the administration and settlement of his estate; but no testi¬ 
mony given by him shall be offered in evidence against him in any 
criminal proceeding. 

Upon examination, should the bankrupt prove an unsatis¬ 
factory or hostile witness by refusing to answer, produce 
records, or by giving evasive replies as to matters with which 


INSOLVENCY PROCEEDINGS 


518 

he must be familiar, or in any other way manifest a disposition 
to withhold information which would be helpful to the trustee 
in tracing certain property, it is within the power of the court 
to confine him for contempt of court. Furthermore, he is 
subject to arrest in event he should refuse to appear for exami¬ 
nation when properly summoned, and also upon satisfactory 
proof that he intends leaving the district to avoid examination. 

While it is the privilege of any bona fide creditor personally 
to question the bankrupt, it has proved most satisfactory and 
expedient to have the examination conducted by an attorney 
skilled in the art and also conversant with bankruptcy pro¬ 
ceedings. 

Disposition of Assets 

In winding up a bankrupt’s estate, everything depends upon 
the trustee, and it is his duty to make a searching investigation 
with a view to recovering every payment made to creditors 
within four months prior to filing of petition and constituting 
a preference within the meaning of Chapter VI, section 60, 
paragraph (a) • 

A person shall be deemed to have given a preference if, 
being insolvent, he has, within four months before the filing of 
the petition, or after the filing of the petition and before the 
adjudication, procured or suffered a judgment to be entered 
against himself in favor of any person, or made a transfer of 
any of his property, and the effect of the enforcement of such 
judgment or transfer will be to enable any one of his creditors to 
obtain a greater percentage of his debt than any other of such 
creditors of the same class. Where the preference consists in 
a transfer, such period of four months shall not expire until 
four months after the date of the recording or registering of the 
transfer, if by law such recording or registering is required. 

In other words, the object of the Bankruptcy Act is to 
provide for an equitable distribution of the property owned by 
the bankrupt four months before the filing of the petition. 

But in order to recover the amount of such payments it is 


BANKRUPTCY 


519 


necessary to prove that the creditor receiving the payment must 

have had reasonable cause to believe the debtor was insolvent 
at the time. 

Debts Having Priority 

The following debts are given priority over the claims of 
general creditors in Chapter VII, section 64: 

1. All taxes due to the United States, the state, county 

district, municipality, or any board having legal right 
to levy taxes. 

2. The necessary costs of preserving the estate subsequent 

to filing the petition. 

3. The filing fees in involuntary proceedings, and the 

reasonable expenses of recovering transferred and 
concealed assets. 

4. The cost of administration and one reasonable attorney’s 

fee for services actually rendered to the petitioning 
creditors in involuntary petitions, and to the bankrupt 
in voluntary cases if the court allows. 

5. Wages to employees earned within three months prior 

to bankruptcy proceedings, not exceeding $300 to each 
claimant. 

A judgment creditor has no preference over other unse¬ 
cured creditors unless an execution has been levied on specific 
property at least four months prior to the filing of the petition. 

Distribution of Assets of Bankrupt Partnerships and 
Partners 

Under the Bankruptcy Act the assets of bankrupt partner¬ 
ships and partners are to be distributed in accordance with 
Chapter III, section 5, paragraph (f) : 

The net proceeds of the partnership property shall be ap¬ 
propriated to the payment of the partnership debts, and the net 
proceeds of the individual estate of each partner to the payment 
of his individual debts. Should any surplus remain of the 
property of any partner after paying his individual debts, such 
surplus shall be added to the partnership assets and be applied 


520 


INSOLVENCY PROCEEDINGS 


to the payment of the partnership debts. Should any surplus 
of the partnership property remain after paying the partnership 
debts, such surplus shall be added to the assets of the individual 
partners in the proportion of their respective interests in the 
partnership. 

Inconsistent as it may seem, it is entirely possible that a 
firm or partnership may be bankrupt and the individuals com¬ 
prising it solvent. Hence, where an act of bankruptcy, in which 
one partner did not participate, has been committed by an 
insolvent firm, the partnership and the participating partner 
may be adjudged bankrupt in an involuntary proceeding, 
though the court has no jurisdiction in such proceeding so to 
adjudicate the non-participating member. Such a situation 
presents a point of particular interest to firm creditors, namely, 
as to the assets available for the payment of dividends. 

The common law partnership principle, upon which the 
right of the partnership creditor to look to the estate of the 
individual partner is based, is that each partner is liable for the 
whole of the partnership debts. Under circumstances such as 
we are assuming, a legal fiction permits the creditors to share 
in the assets of the non-participating partner. This is made 
possible through adoption of the theory that under the Bank¬ 
ruptcy Act each partner occupies the position of surety for the 
firm, and, as on the default of a principal obligor the liability 
of his surety becomes absolute, a creditor is allowed to prove 
his claim against the estate of the surety on this absolute 
liability, regardless of the financial condition of the principal. 3 

Dividends 

With regard to the payment of dividends to creditors, this 
phase of closing up the estate is fully covered in Chapter VII, 
sections 65 and 66: 

Dividends of an equal per centum shall be declared and paid 
on all allowed claims, except such as have priority or are secured. 

The first dividend shall be declared within thirty days 


8See XVIII, Har. Law. Rev., 495. 



BANKRUPTCY 


521 


after the adjudication, if the money of the estate in excess of the 
amount necessary to pay the debts which have priority and 
such claims as have not been, but probably will be, allowed 
equals five per centum or more of such allowed claims. Dividends 
subsequent to the first shall be declared upon like terms as the 
first and as often as the amount shall equal ten per centum 
or more and upon closing the estate. Dividends may be de¬ 
clared oftener and in smaller proportions if the judge shall 
so order; Provided, That the first dividend shall not include 
more than fifty per centum of the money of the estate in excess 
of the amount necessary to pay the debts which have priority 
and such claims as probably will be allowed: And provided 
further, That the final dividend shall not be declared within 
three months after the first dividend shall be declared. 

Dividends which remain unclaimed for six months after the 
final dividend has been declared shall be paid by the trustee 
into court. 

Dividends remaining unclaimed for one year shall under 
the direction of the court be distributed to the creditors whose 
claims have been allowed but not paid in full, and after such 
claims have been paid in full the balance shall be paid to the 
bankrupt; Provided, That in case unclaimed dividends belong 
to minors such minors may have one year after arriving at 
majority to claim such dividends. 

The trustee is presumably competent to dispose of the assets 
to the best interests of the creditors, and once they have mani¬ 
fested their choice the policy of the creditors should be one 
of careful observance but non-interference, except in case of 
flagrant mismanagement, and then the matter should be taken 
up with the referee, for if there is some valid objection to the 
trustee, or the manner in which the estate is being handled, he 
may be removed for cause, and another trustee appointed. 

Settlement by Composition 

The proceedings may also be terminated by the bankrupt 
effecting a “composition settlement” with his creditors, which 
simply means that it is possible for a debtor either before or 
after being adjudged a bankrupt to arrange, generally by 
obtaining financial assistance from outside sources, a settlement 


522 


INSOLVENCY PROCEEDINGS 


satisfactory to a majority of the creditors, in number and 
amount, who thereupon petition the court to allow it, and by 
so doing, compel the other creditors, in the absence of fraud, 
to be bound by it. Such a settlement is made possible and 
provided for in Chapter III, section 12 : 

A bankrupt may offer either before or after adjudication, 
terms of composition to his creditors after, but not before, he has 
been examined in open court or at a meeting of his creditors, 
and has filed in court the schedule of his property and the list of 
his creditors required to be filed by bankrupts. In compositions 
before adjudication the bankrupt shall file the required schedules, 
and thereupon the court shall call a meeting of creditors for 
the allowance of claims, examination of the bankrupt, and 
preservation or conduct of estates, at which meeting the judge 
or referee shall preside; and action upon the petition for adjudi¬ 
cation shall be delayed until it shall be determined whether such 
composition shall be confirmed. 

An application for the confirmation of a composition may 
be filed in the court of bankruptcy after, but not before, it has 
been accepted in writing by a majority in number of all creditors 
whose claims have been allowed, which number must represent 
a majority in amount of such claims, and the consideration 
to be paid by the bankrupt to his creditors, and the money 
necessary to pay all debts which have priority and the cost of 
the proceedings, have been deposited in such place as shall be 
designated by and subject to the order of the judge. 

The judge shall confirm a composition if satisfied that (1) 
it is for the best interests of the creditors; (2) the bankrupt 
has not been guilty of any of the acts or failed to perform any 
of the duties which would be a bar to his discharge; and (3) 
the offer and its acceptance are in good faith and have not been 
made or procured except as herein provided, or by any means, 
promises, or acts herein forbidden. 

It is a fraud upon a creditor who is a party to a composition 
agreement for the debtor to make a secret contract with any 
other creditor whereby the latter is promised more than his 
pro rata share as an inducement for him to join in the compo¬ 
sition. A composition agreement which provides for a pro 
rata payment to all of the creditors entitles each creditor to 


BANKRUPTCY 


523 


assume that all of the creditors are to be treated alike, and 
hence the preference may be said to be fraudulent as to him 
if he was ignorant of it. The law, therefore, permits him, 
upon discovering the facts, to disregard the release he gave and 
to sue for the unpaid balance of his original claim. 4 

Chapter III, section 14, paragraph (c) provides for the 
discharge of the bankrupt under such circumstances: 

The confirmation of a composition shall discharge the 
bankrupt from his debts, other than those agreed to be paid 
by the terms of the composition and those not affected by 
a discharge. 

Ordinarily, the main purpose of the bankrupt in effecting 
such a settlement is to regain possession of the assets with a 
view either to continuing in business or disposing of them at 
a profit as a going concern. 

Any creditor who thinks that the debtor is not offering 
enough may offer to take over the stock himself and to pay 
the other creditors a higher dividend. This usually brings a 
higher offer from the bankrupt if he is trying to defraud his 
creditors. The creditor making the offer must also pay the 
expense of the proceedings up to the time the compromise is 
made. 

Otherwise, when all of the assets of the bankrupt have been 
converted into money and the proceeds distributed among the 
creditors, the duties of the trustee terminate with the comple¬ 
tion of the administration of the estate. 

Discharge of Bankrupt 

When the bankrupt has made an honest accounting of all 
his debts and belongings, and has done all in his power to 
facilitate the proceedings, he is entitled to a discharge. When 
granted, this relieves him of the legal obligation to pay in full 
any of the debts which were included in the proceedings, and 


4 See Schaub and Isaacs, The Law in Business Problems, p. 432 . 



5^4 


INSOLVENCY PROCEEDINGS 


he cannot thereafter be proceeded against at law unless he 
acknowledge in writing that such debts are still due and owing. 

A discharge in bankruptcy does not discharge the obliga¬ 
tion, but it affords the bankrupt a defense to being held legally 
liable on the obligations listed in his schedule. In other words, 
the effect of the discharge is not to discharge the claim, and 
consequently, if a creditor should sue on his original claim 
after such a discharge has been granted, he could recover unless 
the discharge in bankruptcy is set up as a defense to the action. 

Even after a discharge in bankruptcy has been granted to 
a bankrupt, the moral obligation to satisfy his creditors in full 
still persists, and when able, the bankrupt should feel in honor 
duty bound to pay the remaining amounts due. 

Chapter III, section 14, paragraph (a) provides: 

Any person may, after the expiration of one month and 
within the next twelve months subsequent to being adjudged 
a bankrupt, file an application for a discharge in the court of 
bankruptcy in which the proceedings are pending. 

The act also provides in paragraph (b) of the same section 
when a discharge shall not be granted: 

The judge shall hear the application for a discharge and 
such proofs and pleas as may be made in opposition thereto by 
the trustee or other parties in interest, at such times as will give 
the trustees or parties in interest a reasonable opportunity to be 
fully heard, and investigate the merits of the application and 
discharge the applicant unless he has (1) committed an offense 
punishable by imprisonment as herein provided; or (2) with 
intent to conceal his financial condition, destroyed, concealed, 
or failed to keep books of account or records from which such 
condition might be ascertained; or (3) obtained money or 
property on credit upon a materially false statement in writing, 
made by him to any person or his representative for the pur¬ 
pose of obtaining credit from such person; or (4) at any time 
subsequent to the first day of the four months immediately 
preceding the filing of the petition transferred, removed, de¬ 
stroyed, or concealed or permitted to be removed, destroyed, 
or concealed, any of his property, with intent to hinder, delay, 


BANKRUPTCY 


5 2 5 


or defraud his creditors; or (5) in voluntary proceedings been 
granted a discharge in bankruptcy within six years; or (6) in the 
course of the proceedings in bankruptcy refused to obey any 
lawful order of, or to answer any material question approved 
by the court; Provided, That a trustee shall not interpose objec¬ 
tions to a bankrupt’s discharge until it shall be authorized so 
to do at a meeting of creditors called for that purpose. 

A “saving clause” in the act, Chapter III, section 15, para¬ 
graph (a), further provides for a possible revocation of the 
discharge, under certain conditions: 

The judge may, upon the application of parties in interest 
who have not been guilty of undue laches, filed at any time 
within one year after a discharge shall have been granted, 
revoke it upon a trial if it shall be made to appear that it was 
obtained through the fraud of the bankrupt, and that the 
knowledge of the fraud has come to the petitioners since the 
granting of the discharge, and that the actual facts did not 
warrant the discharge. 

In other words, if there has been any fraud in bringing 
the proceedings, or in concealing property which should have 
been surrendered for the benefit of creditors, any of the 
defrauded creditors may come in within a year after the dis¬ 
charge has been granted and have it revoked. What is often¬ 
times not realized until it is too late to profit by it is that 
“honesty is always the best policy” for an insolvent debtor to 
adopt in dealing with his creditors, and this is particularly true 
in bankruptcy proceedings. 

All creditors receive 30 days’ notice of all hearings upon 
such applications. Chapter VI, section 58, paragraph (a-9) 
says: 

There shall be 30 days notice of all applications for the 
discharge of bankrupts. 

And any creditor who intends to oppose it must file with the 
clerk of the court a sworn statement, on a prescribed form, 
stating briefly his intentions and the grounds on which the 
discharge is to be opposed. 


526 


INSOLVENCY PROCEEDINGS 


There is, finally, a further distinction between voluntary 
and involuntary bankruptcy based on Chapter III, section 14, 
which denies a discharge to a bankrupt who has been granted 
a previous discharge within the preceding 6 years. In other 
words, a debtor may not obtain two discharges in bankruptcy 
within 6 years, provided the first was voluntary. Hence the 
advisability of persuading an insolvent debtor to file his own 
petition. 

Concealment of Assets in Bankruptcy Cases 

Although section 29 of the Bankruptcy Act has made it 
a crime for a debtor to have “concealed, while a bankrupt, or 
after his discharge, from his trustee any of the property 
belonging to his estate in bankruptcy,” experience has shown 
that this is one of the usual incidents to be expected in the 
ordinary dishonest bankruptcy case. Although the commercial 
community demands a criminal prosecution in an extraordi¬ 
narily flagrant case of concealing assets, the average merchant’s 
primary interest is merely to recover such assets as to make his 
dividend from the estate as large as possible. He is willing 
that such dishonest merchants shall be punished, but he will 
usually forego this desire if the bankrupt tempts him to accept 
a composition by giving him a few cents on the dollar more 
than “the assets in sight” will yield. While this may be due 
in part to a lax commercial standard among merchants, the 
principal cause of it is found in the attitude of many of the 
courts in demanding a standard of proof concerning concealed 
assets, which is commercially impracticable. 

The courts have generally laid it down as a fundamental 
axiom in this class of cases that they will not make an order 
on the bankrupt to turn over to his trustee secreted assets which 
he is alleged to be wrongfully withholding unless they are 
prepared to follow up a non-compliance with such order by a 
further order committing him for contempt of court. 5 The 


6126 Fed. 464. 



BANKRUPTCY 


527 


result therefore is that the inquiry concerning assets wrong¬ 
fully concealed by a bankrupt from his trustee naturally divides 
itself into two distinct lines of investigation: The first is 
whether any assets have been secreted by the bankrupt, and if 
so what they are; the second is what can be done by the credi¬ 
tors of the bankrupt to procure the return of the assets. 

The first question is necessarily one of fact and it behooves 
the creditors or trustee to present such evidence to the court 
as would justify the inference that there has been a concealment 
of assets. 

■6 

Returning Concealed Assets 

A question which presents far greater perplexities, however, 
is what the court will require in the way of proof as to the 
bankrupt’s ability to comply with an order to return assets 
which the court is willing to believe have been wrongfully 
withheld from the bankrupt’s estate. On this question there 
is a wide divergence of legal opinion, ranging between two 
extreme views. The one view is : 

The rule by which this issue is to be determined is that the 
property of the bankrupt estate traced to the recent possession 
or control of the bankrupt is presumed to remain there until 
he satisfactorily accounts to the court for its disappearance 
or disposition. He cannot escape an order for its surrender 
by simply adding perjury to fraudulent concealment or misappro¬ 
priation. It is still the duty of the referee and of the court, 
notwithstanding his oath and testimony, if satisfied beyond 
a reasonable doubt that he has property of the estate in • his 
possession or under his control, to order him to surrender 
it to the trustee, and to enforce that order by confinement 
as for contempt. 6 

The opposing view holds: 

It follows unquestionably that an order imprisoning a 
bankrupt for contempt for failure to obey a decree to pay 


6 116 Fed. 131. 



528 


INSOLVENCY PROCEEDINGS 


money or to surrender goods into court, is erroneous as a matter 
of law where the bankrupt by sworn answer denies that he has 
the money or the goods and it does not appear clearly affirma¬ 
tively from the record, notwithstanding his denials, that he has 
the power to comply with the decree. The bankrupt is entitled 
to at least that much protection if indeed the courts are to 
refuse to follow the wise rule of the common law which makes 
the sworn denials of the answer sufficient defense to the contempt 
proceedings, leaving the question of the truth of the answer 
to be contested in a prosecution for perjury. 7 

Whichever of these opinions is followed, the inevitable 
conclusion is that no order is to be made on the bankrupt unless 
the court is satisfied beyond a reasonable doubt that the bank¬ 
rupt has the secreted assets in actual possession or control. 
The requirement of stronger evidence than “a preponderance” 
in both instances is undoubtedly due to the criminal aspect of 
proceedings to compel a restitution of property and its legal 
complement of contempt proceedings for a failure to carry out 
such an order when issued. 

This excessive caution on the part of the courts has no 
doubt been prompted largely by their desire to prevent a harsh 
or abusive use of the Bankruptcy Act by overzealous creditors 
against their debtors. Such a view is at least to be inferred 
from the remarks of the court in deciding the case of In re 
Davidson : 8 

Creditors who sell to persons of doubtful or unknown 
financial standing, and of unknown or suspicious character or in¬ 
tegrity, and who by their own lack of ordinary diligence have 
become the victims of fraud, should proceed for redress under 
the ordinary methods of legal procedure and cannot expect 
to use, as an ordinary agent, in the collection of their debts, the 
power to imprison for contempt, which is to be applied only 
in cases of contumacious resistance to the orders of the court. 9 

7 142 Fed. 68. 

8 143 Fed. 173. 

9 See XXIII, Har. Law. Rev., 30. 



CHAPTER XLI 


THE HANDLING OF INSOLVENT ESTATES 

Causes of Commercial Insolvency 

In discussing the four ways in which an insolvent estate 
may be administered, it has very likely occurred to the reader 
that the basic distinction between an adjustment, or assignment, 
and bankruptcy is x that the main object in the former is to 
assist the debtor in working out his difficulties and enabling 
him to continue in business, whereas in bankruptcy the main 
object is to wind up the business as soon as possible. 

In this connection one must always keep in mind the fact 
that once a debtor is insolvent he is at the mercy of his 
creditors, so that it rests with them to decide whether the 
debtor’s estate is to be handled as an adjustment or a liquida¬ 
tion. 

The question then arises as to what determines whether 
an insolvent debtor is deserving of the necessary assistance 
of his creditors, and when is it to the best interests of all 
concerned to make it possible for him to continue in business. 
This depends primarily on the cause of the debtor’s condition, 
as it may be due to one of the usual causes of failure or to 
some extraordinary cause over which the debtor has had little 
or no control. In other words, the causes of commercial 
failure may be classed as “curable” and “incurable.” Con¬ 
servatively speaking, however, scarcely one-fourth of the in¬ 
solvencies occurring in ordinary times are due to unavoidable 
misfortunes, and at least three-fourths may be traced to some 
mental or moral shortcoming varying in degree from pitiful 


529 


53° 


INSOLVENCY PROCEEDINGS 


incompetency to sheer deliberate roguery. For purposes of 
convenience these causes may be classified as: 


Usual 

1. Indolence, neglect, or lack of 

initiative. 

2. Unwise credits or poor collec¬ 

tions. 

3. Overtrading on his capital. 

4. Too heavy operating expense. 

5. Too large drawing accounts. 

6. Too many interested parties. 


Extraordinary 

1. Sickness. 

2. Death of partner. 

3. Failure in some collateral in¬ 

vestment. 

4. Liability on accommodation 

paper. 

5. Fire and floods. 

6. Unexpected failure of large cus¬ 

tomers. 

7. Embezzlement by trusted em¬ 

ployee. 


Lack of Training and Character 

Another contributing and an exceedingly large cause of 
commercial failure is lack of training. Quite a number of 
the reasons customarily assigned for the failure of merchants 
may be grouped together under this head, and it is exceedingly 
significant. This lack of training is to be distinguished from 
lack of ability, for a merchant may have the requisite latent 
ability but the absence of training may render him insufficient 
to make a success of the enterprise in which he is engaged. 

Still another contributing and important cause of com¬ 
mercial failure is found in lack of character. A defect in 
character will lead a merchant to take advantage of his cred¬ 
itors in a financial pinch, if he can. It may lead him to 
neglect the proper rules of business, to be indifferent about the 
keeping of proper books of account, and it may be the whisper 
that tells him how very easy it will be to put over a game on the 
credit man today, and that he might just as well profit by the 
ease with which credits may be obtained, as have so many 
others. There is probably nothing that works so surely against 
the success of a merchant or at the same time affords a greater 
menace to creditors than the lack of character. 1 


1 Causes of Commercial Failures, published by National Association of Credit Men. 



INSOLVENT ESTATES 


531 


Points of Inquiry 

In investigating the financial condition of a merchant, the 
procedure should be somewhat as follows: 

i* Take the bank account and add the deposits. 

2.. Add the cash sales; also the collections. 

3. Compare (1) with (2) to determine how much money 

did not go into the bank. 

4. Compare deposits by months with the corresponding 

months of the previous year, likewise the sales, and 
if the sales are found to have been greater and the 
deposits smaller, there must be some reason for it. 

5. Note if the number of checks drawn to “Cash” is 

unusually large, the fact that the payee is not named 
looks suspicious. 

6. Find out if any of the receivables are pledged 

7. Examine carefully the list of accounts receivable: (a) as 

to character of accounts, (b) time of maturity. 

Any one of the first six causes of commercial insolvency 
may be said to constitute poor business and the presumption is 
therefore in favor of liquidation, whereas in the other seven 
the presumption is in favor of an adjustment, and an exten¬ 
sion of a few weeks generally suffices to determine the advis¬ 
ability of continuing the business. If the experiment proves 
successful, an amicable settlement is arranged with the 
creditors. 

Suppose some of the creditors are opposed to such a settle¬ 
ment and insist upon immediate payment of the entire account. 
If they are in the minority, a “composition before adjudication” 
in bankruptcy is the only means whereby a compromise settle¬ 
ment may be forced on such obstreperous creditors, i.e., suit 
is filed by three creditors to have the debtor adjudged a bank¬ 
rupt, whereupon the debtor asks for a creditors’ meeting in 
order to consider an adjustment, and the court thereupon stays 
proceedings until the composition settlement is confirmed. 
Creditors should always make it a point to insist upon the 


532 


INSOLVENCY PROCEEDINGS 


money being put up before voting in favor of such a settle¬ 
ment. 

Remedy Not to be Adopted 

An adjustment as a continuous operation should never be 
permitted because: 

1. If the debtor cannot operate alone at a profit, he cer¬ 

tainly cannot with the additional expense of an 
adjuster or liquidator. 

2. With another man running his business, and personal 

gain so long deferred, incentive on the part of the 
debtor is partly destroyed, rendering him incapable 
of his best efforts. 

3. The compensation of an adjuster or liquidator posses¬ 

sing the ability necessary to manage a business, would 
very likely more than offset the increase in earning 
capacity. 

The duty of the credit man in such instances is therefore 
not merely to give the distressed debtor temporary relief, but 
rather to find the cause of the failure and remove it. If the 
cause is such as can be remedied, the debtor may have profited 
by his experience and be deserving of another opportunity in 
business. On the other hand, if the failure smacks of fraud 
or dishonesty or was obviously due to incompetency, the 
credit man owes a duty to the business world to protect it 
against a recurrence of such failures, or, as it has been well 
put, to start such a failure in business again amounts to 
“turning a cripple loose upon the business world with the hope 
that the next time he fails he will not stick your house,” and 
is simply another version of the “save the wolf and kill the 
sheep” doctrine. 

Conclusion—Indices of Credit Efficiency 

Whereas it devolves upon the sales department to see that 
all merchandise manufactured or produced is disposed of as 


INSOLVENT ESTATES 


533 


profitably as possible, it rests with the credit department to 
secure the payment of all the accounts thus created at maturity, 
and to see that losses from bad debts and failure to collect 
these outstandings are reduced to the lowest possible amount. 
In fact, the skill and ability of the credit man is, as a rule, 
judged primarily by the record of losses suffered from bad 
accounts. 

A Fallacious Index 

A small loss record alone, however, means little in judging 
the results or measuring the efficiency of the work of a credit 
department, for it is a very simple and easy task to keep the 
percentage of loss' down to a minimum where no chances 
are taken. In other words, by striving for a lower loss ratio, 
a credit man may become ultra-conservative and thus cause loss 
to his firm through a decrease in the volume of business ac¬ 
cepted, and a corresponding increase in the ratio of overhead 
expense. 

A Proper Index 

Were the required data available, a proper test whereby the 
skill of the credit man may be judged would consist of a 
comparison of the loss record with the volume of business 
rejected over a period of several years rather than of any one 
year, as follows: 

1921 1920 1919 19*8 

(1) Business presented. •••• •••• **" 

(2) Business accepted. •••• - 

(3) Business rejected. . . . 

(4) Percentage of loss. . . 

In other words, the greater the spread between (1) and 
(2) the smaller should be the percentage of loss; or, to put it 
in another way, the more conservative the house is in extend¬ 
ing credit, the smaller should be the percentage of loss suffered 

from incurring bad debts. 

For the purpose of illustration, let us assume that $125,000 






534 


INSOLVENCY PROCEEDINGS 


worth of business is submitted to the credit departments of 
two competitive business houses for acceptance within a given 
year. The first house pursues a liberal credit policy and 
accepts $100,000 of the business, while the other is conservative 
and accepts only $50,000. The result in each case may be 
shown as follows: 

Liberal Credit Policy 


No. 1 accepts. $100,000 

Manufacturer’s profit (15 per cent). i, 5 00 

Loss of iy 2 per cent. i, 5 °° 


Net profit. $I 3 > 5 °° 


Conservative Credit Policy 


No. 2 accepts. $50,000 

Manufacturer’s profit (15 per cent). 7 > 5 00 

Loss of 1/10 of 1 per cent. 500 


Net profit. $7,000 


This shows that the second house has held down its percent¬ 
age of loss at the expense of its business profits, thereby defeat¬ 
ing the very purpose for which it existed. 

Here then we have a sharp division of function with an 
ultimate unification of design—in that the salesman submits the 
business, and the credit man regulates the trading in such a 
way as to procure for the house the maximum return with a 
minimum of loss. It is the fact that the ultimate object of 
the credit man is practically the same as that of the salesman 
that makes it so important and vital to the best interests of 
the company that a close and friendly co-operative spirit should 
exist and be maintained between them. Moreover the moment 
a salesman starts ‘Tucking” the credit department, or a credit 
man assumes an antagonistic attitude toward the sales force, 
they are defeating the very purpose for which they are em¬ 
ployed and developing a state of affairs that will eventually 
militate against the best interests of either the one or the other, 
and possibly both. 












INSOLVENT ESTATES 


535 


It therefore behooves the credit man to appreciate fully 
his position in the service and in a pleasant but forceful manner 
impress upon the salesmen with whom he comes in contact, not 
only the prerogatives with which he is vested by virtue of his 
position, but also his positive duties relative to refusing busi¬ 
ness otherwise attractive. Such an understanding saves many 
an explanation, and, by anticipating, goes far toward over¬ 
coming in its inception the disappointment which might other¬ 
wise follow a loss of business. 







INDEX 


A 

Accbptance, 

Guaranty, notice of, 216 
Indorser of draft, liability of, 424 
Maker of draft, liability of, 424 
Part of goods, 58 
Trade (See “Acceptance, trade”) 
Acceptance, Trade, 

Form, 434 

Banks, adoption advocated by, 438 
Buyer, advantages and disadvantages to, 
437 

Function of, 435 

Obstacles to general adoption of, 439 
Seller, advantages and disadvantages to, 
436 

Use of, 435 

Federal Reserve Board, 433 
Account, Books of. 

Examination of, by creditors, states per¬ 
mitting, 171, 172 
Accounting, , 

Final, of assignee, 475 
In equity, 476 
Accounts, 

Assignment of. 

Non-notification, 399 
Notification, 399 
Objections to, 401 
Purposes of, 400 

Book, as credit instruments, 397-402 
Loss, 280 

Not due, attachment of, 318 
Past due, interest on, 247 
Payable, 137 
Receivable, 133 
Valuation of, 133 
Receiver’s, 494 

Action at Law (See also “Attachment,” 
“Garnishment,” “Lien,” “Replevin”) 
Accepting check subsequent to notifica¬ 
tion of, 272 

Affidavit in proof of claim, 273 
Form, 275 

Against receivers, 485 

Attorneys, bonded, directories of, 271 

Debtor execution-proof, 280 


Action at Law— {Continued) 

Demand for settlement, 273 ) 

Due process of law, meaning of, 293 
Judgment, 278 
Appeal from, 278 
By default, 278 
Execution, 279 

Property exempt from execution of, 
286-293 

Right of enforcement in different states, 
295-298 
Jury trial, 277 

Non-resident, property of, 294 
Sales on execution, 

Judgment creditor purchasing at own 
sale, 280 

Purchaser, rights of, 279 
Statement of claim, 273 
Form, 274 

Statute of Limitations, 281 

Part payment of debt, as affecting, 282 
Summons, 276 
Form, 276 

Supplementary proceedings, 283 
Examination of debtor, 284 
Receiver, functions of, 490 
Rights under, 285 
Adjustment Bureau, 452 
Assignment to, 452 
Functions of, 454 

Liquidation, facilities for conducting, 453 
Administrative Expense, 164 
Adulterated Goods, Contracts for Sale 
of, Illegal, 51 
Affidavit, 

Attachment of goods, 329-332 
Form, 330 
Proof of claim, 273 
Form, 275 
Proof of debt, 512 
Form, 513 

Agencies, Mercantile, 98-107 (See also 
“Credit Information, Sources of”) 
Agreement, Sales, 46 (See also “Sales 
contracts”) 

Form, 46 

Analysis, Statement (See “Statement”) 
Appeal from Judgment, 278 


537 



538 


INDEX 


Appointment, Receiver (See "Receiver”) 
Assets, 

And liabilities, comparison of, 122 
Current, 122 
Defined, 146 
Items included in, 149 
Deferred, 135, 146 

Disposition and concealment of, bank¬ 
ruptcy proceedings (See "Bankruptcy”) 
Entry of, on balance sheet, 116, 146 
Fixed, 123 
Defined, 146 
Items included in, 149 
Intangible, 136, 152 
Non-current, ratio of sales to, 187, 192 
Valuation of, 131-136 

Assignability, Distinction Between 
Negotiability and, 404 
Assignment (See also “Insolvency”) 

Form, 462 
Accounts, 399-401 
Adjustment bureau as trustee, 452 
Functions of, 454 

Liquidation, facilities for conducting, 453 
Advantages of, 436 
Assent of creditors, 464, 467 
Assignee, 

Assignor’s business continued by, 470 
Close of assignment, accounting, 475', 
476 

Compensation, 473 
Expenses of, 472 
Funds, distribution of, 474 
Liability of, 476, 477 
Notice of assignment to creditors, 469 
Proceedings and duties of, 468 
Sale of property—time, mode, and terms 
of, 471, 472 

Surplus, how disposed of, 475 
Who may be, 461 
Attestation, 466 
Bankruptcy, act of, 458 
Benefit to debtor, provision for, avoids, 464 
Certain property exempt from transfer 
by, 461 

Consideration, good and sufficient, 465 
Creditors, alternatives of, 477 
Delivery of, 466 
Execution of, 465 
Expenses of, 472 

Federal Bankruptcy Act does not preclude, 

' 500 

Form of, 462 

Fraudulent or illegal, 478-480 

Receiver of property, appointment of, 
490 

Legal right to make, 459-461 


Assignment—( Continued) 

Property, delivery of, 467 
Recording, 466 

Release of debtor, stipulation for, 463 
Setting aside, 479 
Significance and effect of, 459 
State legislation, effect of National Bank¬ 
ruptcy Law on, 500 
Associations, Unincorporated, 26 
Attachment, 

Affidavit for, 329-332 
Form, 330 
Bond, 332 

Proof, burden of, 333 
Bonds or stock, 324 

Chattel mortgage, property covered by, 

324 

Choses in action, 323 

Mortgagee, interest of, 328 
Collateral security, property pledged as, 

325 

Conditional sales, 325 
Death of defendant, 339 
Debtors, 

Absent, absconding, or concealing them¬ 
selves, 320, 321 
Non-resident, 321 
Debts or accounts not due, 318 
Deed absolute, as security for debt, 328 
Defendent, appearance or non-appearance 
of, 318 

Dissolution of, 339 
Effective date of lien, 337 
Equitable interests, 324 
Exemptions from, 286 

Summary of, in different states, 287-293 
Fixtures, 326 

Goods retained in possession of seller, 

326 

Grounds for, 319 
Insolvency of debtor, 339 
Judgment, lien consummated by, 338 
Kinds of, 317 
Levy of, 334~337 
Mortgagor, interest of, 328 
Nature of, 317 
Officer’s return, 337 
Parties entitled to bring, 319 
Possession of property attached, 338 
Procedure, 329 
Property, kinds of, 323 
Publication, notification by, 318 
Real estate, 327, 337 
Effect of levy upon, 328 
Removal of property from state, 322 
Several, on same property, 338 
Writ of, 333 


INDEX 


539 


Attorney Reports, Source of Credit 
Information, iii 
Attorneys, 

Directories of bonded, 271 

B 

Balance Sheet (See also “Statements”) 
Forms, 118, 120, 121, 156, 157 
Analysis of, 119, 128, 148 
Bonds, 155 

Capital stock, treatment of, 153 
Classified, 116 
Construction of, 116, 145 
Assets, 116, 146 
Liabilities, 116, 147 
Corporate, form of, 158 
Form, 156, 157 
Good-will, valuation of, 152 
Intangible assets, 152 
Items, valuation of, 131-140, 152 
Net worth, determining, 148 
Profit and loss statement, as related to, 144 
Purpose of, 144 
Reserves, classes of, 155 
Surplus, corporate, treatment of, 148 
Bank, 

Check (See “Check”) 

Disability of, as guaranty, 219 
Reports, credit information, no 
Trade acceptances favored by, 438 
Bankruptcy, 

Acts of, 504 
Assets, 

Concealment of, 526 
Disposition of, 518 
Partnerships and partners, 519 
Returning concealed, 527 
Claims, filing, 512 

Power of attorney, 513 
Form, 514 
Proof of debt, 512 
Form, 513 

Composition settlement, 521 
Creditors, meetings of, 516 
Debts given priority, 519 
Discharge in, effect of, 524 
Dividends, payment of to creditors, 520 
Examination of bankrupt, 517 
General letter of attorney in fact, 513 
Form, 515 
Legislation, 

English origin, 498 
Federal, 499 
Purpose of, 501 

State insolvency laws, effect on, 499 
Preference, law on, 518 


B ankruptcy—( Cont i n ued ) 

Proceedings, 

Legal, 506 
Nature of, 502 
Referee in, duties of, 508 
Trustee, duties of, 509-512 
Voluntary and involuntary, 503 
Bill in Equity, 476 
Bills of Lading, 302 

Negotiable and non-negotiable, 416 
Transfer of, 416-418 
Stoppage in transit under, 303-305 
Bonds, 155 

Attachment, 332 

Indemnity, action of replevin, 357 
Levy on interest in, 324 
Borrower, 

Capacity, 92 
Capital, credit factor, 91 
Character, importance of, 90, 94 
Confidence in, essential, 86 
Breach of Contract, 311-313 
Breach of Warranty, 77 
Bulk Sales Law, 

Applicability of, 365 
Constitutionality, 361 

Enactment of, conditions giving rise to, 358 

Enforcement of, process of, 364 

Evasion, 366 

New York State, 360 

Object of, 359 

State statutes, tabular analysis of, 366 
Violation of, creditor’s remedy, 363 
Business, 

Cycle, 195 
Hazards of, 151 
Volume of, 150 
Business Organization, 

Forms of, 7 

Buying Movements, 195 
By-Laws, Corporation, 34 

c 

Cancellation of Orders, 252 
Capacity of Borrower, 92 
Capital, 

Credit factor, 91, 123 
Determining amount of, 123, 150 
Rating, mercantile agency, 98, 99 
Working, defined, 123 

Handling of, proper and improper, 196- 
202 

Science of, 194 

Capital Liabilities, 147, 153 
Capital Stock, 31-34. 153. 154 (See also 
“Corporation”) 


540 


INDEX 


Carrier, Common, 

Action against, 

Damages, measure of, 388 
Rights of carrier, 387 
Compensation of, 

Liability for, 385 
Lien on goods to secure, 386 
Defined, 374 

Discrimination against, Interstate Com¬ 
merce Act, 390 

Liability of (See “Carrier’s liability”) 
Carrier’s Liability, 

Adverse claimant, delivery of goods to, 383 
Bills of lading and express receipts as 
contracts, 379 
Carrying facilities, 376 
Equal for all, 377 
Carrying for all, duty of, 375 
Commencement and termination of, 380 
Connecting carrier, 

Delivery to, 382 
Loss or damage on line of, 383 
Consignee’s refusal to accept goods, 381 
Contracts limiting, 378 
Deviation and delay, 378 
Failure to deliver goods, 383 
Interstate Commerce Commission, 389 
Proceedings before, 391 
Loss or damage, 377 

Goods delivered to connecting carrier, 383 
Limiting amount recoverable, 380 
Time limit of claims for, 380 
Nature and condition of goods, 376 
Nature of his holding out, 375 
Negligence, 379 

Payment in advance, right to demand, 377 
Private carriers, 374 
Rates, discrimination in, 386 
Sale of goods held under lien, 387 
Cash, 

Asset value of, 134 
Discount, 244 

Cash or Sight Draft Customers, 210, 211 
Character, 

Credit factor, 90, 94 

Charter, Corporation, Procedure to 
Obtain, 29 
Chattel Mortgage, 

Form, 221 

Delivery and acceptance, 223 
Discharging of record, 225 
Distinction between conditional sale and, 
225 

Filing, 223 

Omission of, effect of, 225 
Form of, 221 

Levy on property covered by* 324 


Chattel Mortgage —{ Continued ) 

Nature of, 220 

Parties who may make, 222 

Property, 

Description of, 222 
Subject to, 222 
Check, 

Form, 408 
Bad, 

Dishonor, notice of, 425 
Form, 425 

Intent to defraud, 430, 432 
Non-payment, notice of, 250, 409, 429 
Protest, 426 
Form, 427 

Sale and delivery of merchandise pre¬ 
vious to giving of, 431 
State legislation, 428-432 
Certification of. 400 
Bank, liability of, 412 
Maker, liability of, 409 
State legislation. 411 
Defective, 250 
Liability of bank, 411 

Marked “Payment of account in full,” 249 
Use of, 408 

Choses in Action, 323, 328 
C. O. D. Sales, 

Right of inspection, 64 
Title, passing, 63-65 
Collateral Security, 

Attachment of property secured by, 325 
Collection, 

Appeal, tenor of, 267 

Characteristics of successful system, 267 

Compulsion, stage of, 262, 266 

Cost of, 208 

Discussion, stage of, 262, 264 

Legal process of (See “Action at law”) 

Necessity, stage of, 262, 265 

Notification, 262, 263 

Process of, 262-266 

Prompt, turnover as related to, 259 

Reminder, 262, 263 

Slow, influence of, on volume of sales, 260 
Telegraph, use of, 269 

Collector, Merchants’ Ability as, Esti¬ 
mated, 142 

Commission on Uniform State Laws, 81 
Laws recommended and enacted, 81, 82 
Composition Settlements, 450-452, 521 
Forcing, 451 

Continuing Guaranty, 215 
Form, 215 
Contract, 

Guaranty (See “ Guaranty”) 

In restraint of trade, Clayton Law, 51 


INDEX 


541 


Contract —( Continued) 

Sales (See “Sales contracts”) 

Special, carrier’s liability under, 378 
Conversion, 18 

Copartnership, Articles of, 12 (See also 
“Partnerships”) 

Corporation, 

Balance sheet, form of, 158 (See also 
“Balance sheet”) 

Form, 156, 157 
Bonds, 155 
By-laws, 34 
Capital stock, 31-34 
Common, 32 

Entry of, on balance sheet, 153, 154 

Full-paid, 33 

Levy on, 324 

No-par value shares, 32 

Preferred, 32 

Ratio between net income and, 182 
Treasury stock, 33 ' 

Charter, procedure to obtain, 29 
Corporate control, in whom vested, 35-37 
Defined, 28 
Directors, 

Functions and powers of, 36 
Liability of, 40, 42 

Dividends, funds out of which paid, 166 
Dummy incorporators, functions of, 30 
Finances, how handled, 37 
Garnishment, 344 
Implied powers, defined, 38 
Incorporators, who may act as, 30 
Legal liability, 37-41 
Ultra vires acts, 38, 40 
Legislation affecting (See “State legisla¬ 
tion,” “ Federal legislation”) 

Limitation of powers, 31 
Officers, 37 

Liability of, 40 

Receiver, appointment of, 488 
Reports, 41 

Reserves, classes of, 155 

Statement, financial (See “Statement”) 

Stockholders, 35 

California, liability in, 39 
Liability of, 38 
Minnesota, liability in, 39 
States requiring financial statements 
rendered to, 172 
Surplus, 148, 155, 158 
Test of corporate relation, 27 
Treasurer, duties of, 37 
Cost of Collection, 208 
Cost of Goods Sold, 163 
Credit, 

Amount of, determining, 124 


Credit —( Continued ) 

Buying periods, as affecting, 195 
Efficiency, 532 
Test of, 533 • 

Extension of time (See “Extensions, 
granting”) 

Factors essential to granting of, 

Analysis of, 88 
Business conditions, 95 
Capacity of borrower, 92 
Capital of borrower, 91 
Character of borrower, 90, 94 
Confidence in borrower, 86 
Importance of, relative 73 
False statement issued to secure, state 
laws, 175 

Information (See “Credit information, 
sources of,” below) 

Insolvency of buyer subsequent to exten¬ 
sion of, 300 
Instruments of, 

Book accounts, 397-402 
Defined, 397 
Forms of, 397 

Negotiable (See “Negotiable instru¬ 
ments”) 

Non-negotiable, 403, 415-418 
Insurance, 

Advantages of, 231 
Bond, limitations of, 229 
Factors to be considered, 228 
Initial loss, computing amount of, 227, 
228, 229 

Objections to, 232 
Policies, types of, 230 
Shipments guaranteed individually, 233- 
235 

Theory of, 227 

Liquidation periods, as affecting, 195 
Payment of accounts, manner of, 208 
Ratings, 98, 99 
Risk in granting, 85 
Three C’s of, 88 
Credit Clearing House, 

Guaranty of shipments individually, plan 
of, 233-235 

Credit Information, Sources of, 

Agencies, mercantile, 98 

Improvements in, recommended, 102— 

105 

Investigators employed, kinds of, 99 
Legal aspects of, 105 
Ratings, capital and credit, 98, 99 
Reports, special, 100 
Collateral and derivative, 140 
Interchange bureaus, 107 

Theory and value of service, 108 



54 2 


INDEX 


Credit Information, Sources of—( Cont ' d .) 
Judgment of credit man, 112 
Reports, 

Attorney, ill 
Bank, no 

Mercantile agency, special, 100 
Salesmen’s, 109 
Credit Man, 

Attitude of, 96 

Business conditions, close touch with, 
essential, 95 

Co-operative spirit between salesmen and, 
534 

Liberal policy advisable, 96 
Personal judgment of, 112 
Creditor, 

Skill of, judging, 533 
Purchasing at own sheriff’s sale, 280 
State legislation protecting (See “State 
legislation”) 

Customers, Classes of, 210 

D 

Damage, Goods in Transit, 377 (See also 
“Carrier’s liability”) 

Action of replevin, 356 
Carrier, action against, 388 
Debtor, 

Absent or absconding, 320 
Execution-proof, 280 

Extension of time to, 218, 236-242 (See 
also “Extensions, granting”) 
Non-resident, 321 
Release of, 217 
Debts, Floating, 125 
Deferred Assets, 135 
Deficit, Conversion of, into Surplus. 
167 

Delivery of Assignment, 466 
Delivery of Goods, 65 
Sales without, 66 
Demurrage and Storage, 385 
Description, Sale of Goods by. Uniform 
Sales Act, 74 

Deviation and Delay, Liability for, 378 
Directors, 

Corporation, 

Functions and powers of, 36 
Liability of, 40, 42 
Discount, 

Cash, 244 
Unearned, 243 

Methods of treatment, 245 
Discount Customers, 210 
Dissolution of Partnership (See “Part¬ 
nership”) 


Dividends, 

Funds derived from, 166 
Payment of, to creditors, bankruptcy pro¬ 
ceedings, 520 

Surplus, when may be used for, 166 
Draft, 407 

Acceptance of (See “Acceptance, trade 
Bank, 408 
Form, 408 
Commercial, 408 
Form, 408 

Due Process of Law, 293 
Dummy Incorporators, 30 

E 

Earnings, Net, 167 
Efficiency, 

Credit, 532 
Testing, 533 

Execution of Judgment (See “Action at 
law”) 

Expense, 

Administrative, 164 
Operating, 165 

Ratio of, to gross income, 165 
r> Selling, 164 

Express Warranties, 72, 73 
Extensions, Granting, 

Acceptance of a note, 241 

Fraud, deceit, or undue influence, effect 
of, 242 
Accounts, 

Investigation of, 236 
Leniency with, 239 
Tact in closing, 239 
Consideration, new, 240 
Consent of guarantor not obtained, 218 
Insolvent debtors, 448-450 

F 

False Statement Law, 

Federal, 174 
State, 175. 369 
Federal Legislation, 

Bills of lading, uniform, 393 
False statement, 174 

Money or property obtained under false 
pretenses, 174 

Use of mails to defraud, 174 
Federal Reserve Board, 

Use of trade acceptances advocated, 433 
Fixtures, Valuation of, 136 
Floating Debt, 125 
Fraud, 

Acceptance of a note procured by means 
of, 242 


INDEX 


S43 


Fraud—( Continued ) 

Bad checks (See “Check”) 

Legal definition of, 369 
Mails, use of, to defraud, 174 
Prosecution, criminal, 

Compromise and dismissal of case illegal, 
373 

Criminal statutes, 372 
Difficulties in way of, 372 
False Statement Law, 369 
No bar to action for damages, 372 
Sales contracts, 54 

Full Faith and Credit Clause, United 
States Constitution, 296 
Fungible Goods, Passing Title to, 63 
Furniture and Fixtures, Valuation of, 
136 

G 

Gambling Contracts Illegal, 51 
Garnishee (See “Garnishment”) 
Garnishment, 

Costs, 351 

Debt, legal jurisdiction, 347 
Defined, 342 

Funds in hands of receiver not subject 
to, 484 
Garnishee, 

Effect of judgment against, 349 
Liability of, 343 
Must be third person, 348 
Interrogatories, 350 
Judgment debts, 349 
Notice of, 342 
Form, 343 

Persons subject to, 344 
Pre-existing contracts or indebtedness, 347 
Property subject to, 345-347 
General Letter of Attorney in Fact, 
Bankruptcy Proceedings, 513 
Form, 515 
Good-will, 

Valuation of, 152 

Guarantor, 217-219 (See also “Guaranty”) 
Guaranty, 

Forms, 212, 213 
Bank cannot act as, 219 
Consideration, 216 
Continuing, 215 
Form, 215 
Contract of. 

Alteration of, 217 

Entered into at time of contract of 
sale, 216 

Entered into subsequent to contract of 
sale, 216 

Must be in writing, 219 


Guaranty—( Continued) 

Debtor, 

Extension of time to, 218 
Release of, 218 
Default of principal, 216 
Defined, 213 

Distinction between surety and, 213 
Guarantor, 

Death of, 218 
Discharge of, 217 
Remedies of, 218 
Main contract unenforcible, 218 
Notice of acceptance, 216 
Payment and collection, distinction be¬ 
tween, 214 

Statute of Frauds, 219 
Surrender of securities, 218 

I 

Income 

Gross, 

Ratio of operating, expense to, 165 
Net, 165, 166 

Dividends paid out of, 166 
Ratio of, to capital stock, 182 
Ratio of, to total invested assets, 184 
Other, 166 

Income or Profit and Loss Statement 
(See “Profit and loss statement”) 
Insolvency (See also “Bankruptcy”) 
Absolute or temporary, 460 
Adjuster, conditions under which not 
desirable, 532 
Adjustments, 

Bureau plan of, 452-455 
Composition settlements, 450-452 
Extensions, 448-450 
Personal, or amicable, 447 
Assignment (See “Assignment”) 
Attachment of property, 339 
Causes of, 529 

Distinction between bankruptcy and, 444 
Investigation of financial condition, 531 
Justifiable explanation or otherwise, in¬ 
vestigation showing, 446 
Legislation, principle of, 443 
Liquidation, methods of, 452 
Purchaser of assigned property, title of, 472 
Receivership (See “Receivership”) 

Relief, means of, 445 
State legislation, 456, 459 
Stoppage in transit (See “Stoppage in 
transit”) 

. Subsequent to extension of credit, 300 
Insurance, 

Credit (See “Credit insurance”) 


544 


INDEX 


Intangible Assets, 136 
Interchange Bureaus, 107 

Theory and value of service, 108 
Interest, 

Past-due accounts, 247 
Interrogatories, Garnishment Proceed¬ 
ings, 350 

Interstate Commerce Commission, 389 
Proceedings before, 391 
Inventory, Large, Danger of, 162 
Investments, 

Classification of, on balance sheet, 117 
Value of, appraising, 134 
Invoice not Received, Handling Claim 
of, 252 

J 

Joint Stock Companies, 23-26 
Judgment (See “Action at law”) 

L 

Laws, 

Federal (See “Federal legislation”) 

State (See “State legislation”) 

Legal Liability, 

Agencies, mercantile, 105 
Assignees, 476 

Associations and societies, unincorporated, 
26 

Carriers (See “Carrier’s liability”) 
Corporation, 37-41 
Joint-stock company, 24 
Partnerships, 17 
Limited, 22 
Receivers, 494 
Sole proprietorships, 10 
Legal Process of Collection (See “Action 
at law”) 

Levy of Attachment, 334-337 
Liabilities, 

And assets, comparison of, 122 

Capital, 147, 153 

Current, defined, 123, 147 

Entry of, on balance sheet, 116, 147 

Fixed, defined, 123, 147 

Legal (See “Legal liabilities”) 

Valuation of, 137-140 
Lien (See also “Attachment”) 

Carrier’s, 386 
Sale under, 387 

Lost, conditions under which, 301 
Property held by receiver, 484 
Resale of goods, right of, 308 

Time and manner, Uniform Sales Act, 
309 


L ien — ( Continued) 

Rescission, 309 

Uniform Sales Act, 310 
Revived, 301 
Right to, 300 

Limited Partnership (See “Partnerships”) 
Liquidation of Business (See “Insolvency,” 
“Bankruptcy”) 

Loss, Liability for, 

Goods in transit, 377 (See also “Carrier’s 
liability”) 

M 

Machinery, 

Value of, estimating, 135 
Mails, Use of, to Defraud. 174 
Market Declines, Claims for, 250 
Memorandum of Sale, 55 (See also “Sales 
contracts”) 

Form, 56 

Mercantile Agencies, 98-107 (See also 
“Credit information, sources of”) 
Merchandise, 

Ratio of, to— 

Receivables, 186, 188 
Sales, 187, 191 
Returned, 251 
Unpaid for, 137 
Value of, appraising, 132 
Minor, 

Rights of, as partner, 12 
Money, Obtained Under False Pretenses, 
174 

Mortgage, 

Attachment of property under, 328 
Chattel, 220-226 (See also “Chattel 
mortgage ”) 

Due date, importance of, 138 
Right of partner to execute, 18 

N 

Negligence of Carrier, 379 
Negotiable Instrmment, 

Check (See “Check”) 

Collection costs, payment of, 413-415 
Distinction between non-negotiable and, 

403 

Documents of title, 416-418 
Draft, 407 

Acceptance of (See “Acceptances”) 
Bank, 408 
Commercial, 408 
Form, 408 

Irregular transfer, 423 
Legal protection of, 404 


INDEX 


545 


Negotiable Instrument— (. Continued ) 
Negotiation (See “Negotiation”) 

Origin of, 405 

Post office money order, 412 
Form, 413 

Promissory note, 407 
Form, 407 

Requirements of, 405 
Negotiable Instruments Law, 

Payment of collection costs and attorney’s 
fees, 413-415 

States which have enacted, 82 
Negotiability, Distinction Between As¬ 
signability and, 404 
Negotiation, 

Delivery, 419 
Dishonor, notice of, 425 
Form, 425 
Indorsement, 

Blank, 420 

Holder, rights of, 421 » 

Indorser, liability of, 421 
Qualified, 420 
Restrictive, 420 
Special, 420 
Unqualified, 420 

Irregular, defenses of parties to instru¬ 
ment, 423 
Overdue paper, 424 

Presentment of instrument, time, place, 
and mode of, 424 
Protest, 426 
Form, 427 

Net Income (See “Income, net”) 

Net Worth, 122, 148 
Debt, ratio to, 187, 189 
Non-current assets, ratio to, 187, 190 
Ratio of sales to, 187, 191 
Non-delivery of Goods By Carrier, 383 
Non-negotiable Instruments, 

Defined, 403 

Documents of title, 415-418 
Notes, 

Payable, 137 
Promissory, 407 
Form, 407 

Acceptance of, may constitute extension 
of credit, 241 
Dishonor, notice of, 425 
Form, 425 

Indorser, liability of, 424 
Maker, liability of, 424 
Presentment of, 424 
Receivable, 133 
Valuation of, 133 
Notice of Dishonor, 425 
Form, 425 


o 

Officers, Corporation, 37 
Liability of, 40 

Officials, State, Financial Statements 
Rendered to in Some States, 172 
Off-rated Accounts, 230 
Operating Expense (See “Expense”) 
Orders, Cancellation of, 252 
Outlawed Claims, 281 

P 

Partner (See “Partnerships”) 
Partnerships, 

Articles of copartnership, 12 

Importance of careful examination of. 

Bankrupt, distribution of assets, 519 
Controversies, internal, 14 
Creditors, rights of, 18-21 

Change in personnel of partnership, 20, 
21 

From whom may collect, 16, 17 
Defined, 11 
Dissolution, 15-17 

Accounting, manner of, 14 
Contractual power of partner pending 
notice of, 21 

Defined, Uniform Partnership Act, 15 
Factors bringing about, 16 
Evidence of existence of, 13 
Firm name, 14 
General, 11 

Joint-stock companies, 23-26 
Corporation compared with, 24 
Legal liability, 24 
Statutory enactments, 25 
Legal liability, 17 
Limited, 21-23 
Legal liability, 22 

Organization of, legal requirements, 22 
Purpose of, 21 
Minors, rights of, 12 
Partner, 

Bankruptcy of, 17 

Creditors of, 18 

Death of, 16 

Insanity of, 17 

Liability of, 17 

Minor as, rights of, 12 

Misconduct of, 17 

Mortgage, right to execute, 18 

Retired, liability of, 20 

Who may be, 12 

Withdrawal of, 16 


5^6 


INDEX 


Partnerships—( Continued) 

Property, firm, 14 

Illegally sold, recovery of, 19 
Receiver, appointment of, 487 
Test of existence of, United States Supreme 
Court, 12 

Transfer of interest in, effect of, 23 
Past-due Accounts, 

Interest on, 247 

Payment in Advance, Right of Carrier 
to Demand, 377 
Payment of Accounts, 

Checks, 

Defective, 250 

Marked “Payment of account in full,” 
249 

Collection (See “Collection”) 

Credit standing of purchaser, 208 
Forcing (See “Action at law”) 

Guaranty of payment and guaranty of 
collection, distinction between, 214 
Profits as related to, 205 
Time of, effect on profits, 206 
When due, ability of buyer, 123 
Plant, Machinery, and Tools, 

Value of, estimating, 135 
Pledge, Distinction Between Condi¬ 
tional Sale and, 226 
Policies, Credit Insurance, 230 
Poor-pay Customers, 210, 211 
Power of Attorney, Incorporated in 
Proof of Debt, 513 
Form, 514 

Production, Length of Period of, 151 
Profit, 

Gross, 163 

Payment of accounts as related to, 205-207 
Profit and Loss Statement (See also 
“Statement”) 

Balance sheet, as related to, 144 

Cost of goods sold, 163 

Deficit, conversion of into surplus, 167 

Earnings, net, 167 

Expenses, 

Administrative, 164 
Selling, 164 
Fixed charges, 167 
Form of, 159 
Function of, 159 

Income—net, gross, and other, 165-167 
Profit, gross, determining, percentage of, 
163 

Sales, gross, 161 

Surplus, analysis of fluctuations of, 167 
Value of, to credit man, 159 
Proof of Debt, 512 
Form, 513 


Property, 

Exemptions from attachments and execu¬ 
tion, 286-293 

Non-resident, legal procedure, 294 
Obtained under false pretenses, 174 
Purchase, Credit Terms of, 15 i 

Q 

Quality, Implied Warranty of Uniform 
Sales Act, 75 

R 

Rated Accounts, 230 
Ratio, 

Debt to net worth, 187, 189 
Direction in which moving, 187 
Net income to— 

Capital stock, 182 
Total invested assets, 184 
Net worth to non-current assets, 187, 190 
Receivables to merchandise, 186, 188 
Sales to— 

Merchandise, 187, 191 
Net worth, 187, 191 
Non-current assets, 187, 192 
Receivables, 187, 190 
Window dressing, 187 
Real Estate, 

Attachment of, 327, 337 (See also “Attach¬ 
ment”) 

Receivables, 

Merchandise, ratio to, 186, 188 
Ratio of sales to, 187, 190 
Receiver, 

Accounts of receipts and disbursements, 495 
Appointment of, 

Application for, 481 

Classes of cases warranting, 486 

Corporation, 488 

Effect of, 481 

Partnership, 487 

Principles on which based, 482, 489 
Supplementary proceedings, 490 
Bonding of, 494 
Compensation, 494 
Duties, 493 

Liabilities for acts, 494 
Powers and limitations of, 492 
Property in possession of, 

Books and documents open to examina¬ 
tion, 485 

Garnishment illegal, 484 
Legal status of, 484 
Removal and discharge of, 496 
Selection of, 483 
Suits against, 485 


INDEX 


547 


Records, 

Examination of, by creditors, states per¬ 
mitting, 171, 172 

Referee in Bankruptcy, Duties of, 508 
Replevin, 

Bond of indemnity, 357 
Damages, 356 

Defenses barring action, 356 
Demand for return of goods, 355 
Legal procedure, 353 
Possession, right to, necessary, 354 
Property subject to, 355 
Receiver cannot maintain, 484 
Writ of, 353 
Form, 354 
Reports, 

Corporation, 41 

Credit information (See “Credit informa¬ 
tion”) 

Resale, Right of, 308 
Reserves, 137, 155 

S 

Sale, 

Assigned property, 471, 472 
Memorandum of, 55 (See also “Sales 
contracts ”) 

Form, 56 

Sheriff’s (See “Action at law”) 

Terms of, 151 
Sales, 

Agreement, 46 (See also “Sales contracts”) 
Form, 46 

Bill of lading, transfer of, 415 
C. O. D., right of inspection, 64 
Title, passing, 63-65 

Conditional, 67-70 (See also “Sales con¬ 
tracts” below) 

Form, 68 

Contract (See “Sales contracts” below) 
Distinction between contract to sell and, 
45 

Uniform Sales Act, 47 
Expense, 164 

Goods in bulk (See “Bulk Sales Law”) 
Goods in possession of seller, attachment 
of, 326 

Goods sold by description, implied war¬ 
ranty, 74 
Gross, 161 

Comparison of, with final inventory, 162 
Monthly, compared with amount of stock, 
143 

Ratio to— 

Merchandise, 187, 191 
Net worth, 187, 191 


Sales—( Continued ) 

Ratio to—( Continued ) 

Non-current assets, 187, 192 
Receivables, 187, 190 
Title, passing, 61-71 
Approval sales, 64 
C. O. D. sales, 63-65 
Contract of sale unconditional, 62 
Delivery, 65 
Fungible goods, 63 

Goods not in deliverable condition, 62 
Intent of parties, 62 
Time of, importance of, 61 
Void and voidable title, distinction 
between, 70 
Without delivery, 66 

Volume of, compared with total expenses, 
142 

Warehouse receipt, transfer of, 415 
Warranties of goods (See also “War¬ 
ranties”) 

Express, 72 
Implied, 73 - 75 . 77 
Oral, 77 

Sales Contracts, 

Form, 46 

Breach of, action for, 311-313 
Damages, measure" of, 311, 313 
Conditional, 67-70 
Form, 68 

Affidavits to, important, 68 
Attachment of goods, 325 
Destruction of property, 69 
Distinction between a pledge and, 226 
Distinction between chattel mortgage 
and, 225 

Fraud, opportunity for, 68 
Redemption of goods by buyer, 69 
State laws on, 70 

Uniform Conditional Sales Act, 69 
Fraud, 54 
Illegal, 

Adulterated goods, 51 
Contracts in restraint of trade, 51 
Gambling contracts, 51 
Legal distinction between sale and, 45 
Uniform Sales Act, 47 
Letters may constitute, 46, 48 
Moment at which binding, 48, 49 
Made in one state to be performed in 
another, 78 

Memorandum of sale, 55 
Form, 56 

# Mistake, effect of, 52 

Outlawed, Statute of Limitations, 281 
Part of goods received and accepted, 58 
Part payment, 59 


548 


INDEX 


Sales Contracts—( Continued ) 

Requisites of, 47-54 

Competency of parties, 49 
Consideration, 50 
Correctness, 52 
Free will of parties, 54 
Legality of object, 51 
Mutual assent, 48 
Truthful representation of facts, 54 
Statute of Frauds, 54-60 
Title, passing of, 61-71 (See also “Sales”) 
Unconditional, 62 
Uniform state laws, 

Enacted at present time, 81, 82 
How obtained, 81 
Lack of, 79 

National commission for, 80 
Validity of. 

Contracts of sale, 79 
Contracts to sell, 78 
Laws governing, 78-82 
Statute of Limitations, 78 
Transitory causes of action, 78 
Salesmen’s Reports, Value of, as Source 
of Credit Information, 109 
Sample, 

Sale of goods by, Uniform Sales Act, 75 
Securities, 

Classification of, on balance sheet, 117 
Surrender of, by creditor, 218 
Selling Expense, 164 

Settlement, Forcing (See “Action at law”) 
Sheriff’s Sale (See “Action at law”) 
Shipment, 

Goods unfit for, 376 
Shipments, 

Checking, 247 

Shortage, Handling Claims for, 247 
Slow-pay Customers, 210 
Societies, Unincorporated, 26 
Sole Proprietorship, 9, 10 
Legal liability, 10 
Restrictions, statutory, 9 

Special rulings in certain states, 10 
Rights of individual, 9 
State Legislation, 

Bills of lading, uniform, 392 

Bulk Sales Laws, tabular analysis of, 366 

Certification of checks, 

Bank, liability after, 412 
Maker, liability after, 411 
Checks, liability of bank, 411 
Collection costs, negotiable instruments, 

413-415 

Conditional sales, 70 

Examination of records and books of 
account, states permitting, 171, 172 


State Legislation—( Continued ) 

False statement issued to secure credit, 
175 , 369 

Insolvency laws, 456, 459 

Effect of National Bankruptcy Act on, 
499 

Judgment, right of enforcement in different 
states, 295-298 

Property exempt from attachment and 
execution, summary of, 286-293 
Publication of financial statements, states 
requiring, 169 

State officials, rendering financial state¬ 
ments to, 172 

Stockholders, states requiring financial 
statements rendered to, 172 
Uniform, 

How obtained, 81 
Lack of, 79 

Laws enacted at present time, 81, 82 
National commission for, 80 
Statement (See also “Balance sheet,” 
“Profit and loss statement”) 

Forms, 118, 120, 121 
Analysis of, 114-130 
Acid test, 130 

Assets and liabilities of, comparison of, 
122 

Illustrated, 126, 127, 138-140 
Objects to be gained by, from credit 
point of view, 123-125 
Theory of, 119, 128, 148 
Assets and liabilities, 

Classes of, 122, 146-148 
Credit point of view, 122 
Comparative, 

Form, 183 

Ratios obtained from, as indices of 
credit strength, 180-193 (See also 
“Ratio”) 

Value and use of, 179 
Defined, 144 
False, 

Federal law, 174 
State laws, 17S 
Form of, 115, 119 
Items, arrangement of, 116, 145 
Parties interested in, 115 
Publication of, states requiring, 169 
Statement of Claim, 273 
Form, 274 

Statute of Frauds, 54 

Contract for work and labor not within, 57 
English, Section 17, 55 
Guaranty and surety contracts, 219 
Non-compliance with, effect of, 60 
Parts of goods received and accepted, 58 


INDEX 


549 


Statute of Frauds— [Continued) 

Part payment, 59 

Purchase of several articles each under 
statutory limits, 57 
Statute of Limitations, 

Breach of contract, claim for, 281 
Exceptions, 282 
Sales contracts, 78 

Stock, Capital, 31-34 (See also "Corpora¬ 
tion”) 

Stockholders, 

Liability of, 38 
Rights of, 35 

States requiring financial statements ren¬ 
dered to, 172 

Stoppage in Transit, 302 
Method of, 307 

Time goods considered in transit, 306 
Under bill of lading, 303-305 
Effect of, 305 
Grounds for, 305 

Uniform Sales Act, 304, 306, 307, 309 
Storage, 385 
Summons, 276 
Form, 276 

Supplementary Proceedings, 283-285 
Surety, 

Contract of, must be in writing, 219 
Defined, 213 

Distinction between guaranty and, 213 
Notice to, on default of principal, 216 
Surplus, 155, 158 

Analysis of fluctuations of, 167 
Paying dividends out of policy discussed, 
166 

T 

Title, 

Passing of (See "Sales”) 

Void, 70 
Voidable, 71 

Tools, Value of, Estimating, 135 
Trade Acceptance (See “Acceptance, 
trade”) 

Transit, 

Goods in, carrier’s liability (See Carrier’s 
liability”) 

Stoppage in (See "Stoppage in transit”) 
Time goods considered in, 306, 380 
Treasury Stock, 33 
Trial of Claim, 277 

Trustee, Bankruptcy, Duties of, 509-512 
Turnover, 259 

Indicative of business ability, 141 
Method of figuring, 141 


u 

Ultra Vires Acts, 38 
Directors, corporation, liability of, 40 
Unearned Discount, 243, 245 
Uniform Bill of Lading Acts, 

Federal, 393 
States adopting, 392 

Uniform Conditional Sales Act, Re¬ 
demption of Goods by Buyer, 69 
Uniform Partnership Act, 

Dissolution defined, 15 
Uniform Sales Act, 

Description, sale of goods by, 74 
Goods in transit, 306 
Goods left in seller’s possession, 66 
Third party purchasing, 67 
Lien, 

Loss of, 301 
Right to, 300 

Quality, implied warranties of, 75 
Resale, when buyer is in default, 309 
Rescission, time and manner of, 310 
Sale and contract to sell, distinction 
between, 47 

Sample, sale of goods by, 75 
States which have enacted, 82 
Stoppage in transit, 304, 306, 307 
Uniform State Laws (See "State legisla¬ 
tion”) 

Unincorporated Associations and Socle* 
ties, 26 

United States Constitution, 

Full faith and credit clause, 296 

w 

Warehouse Receipts, 

Negotiable and non-negotiable, 416 
Transfer of, 416-418 
Warranties, 

Breach of, 77 
Express, 72 

Promise, statement of fact and opinion, 
distinction between, 73 
Implied, 73 

Quality, warranty of, 75 
Sale of goods by description, 74 
Sale of goods by sample, 75 
Uniform Sales Act, 74—76 
Written contract does not exclude, 77 
Oral, 76 

Subpurchasers of goods, 7 
Working Capital (See "Capital”) 

Writ of Attachment, 333 



























































































